The SMSF Trustee wishes to acquire a residential investment property ("Property") from an unrelated party from Currumbin Valley, Qld, 4223 where there are currently 730 properties for sale in the Currumbin Valley and demand for these types of properties are low with buyers few and far between. The total purchase price of the Property (including stamp duty and transaction costs) is $400,000. 

 

The SMSF has $200,000 in cash available to acquire the Property and will borrow the remaining $200,000 from a financial institution ("Bank"). The SMSF has no other assets in the trust. The repayments amount to $570 / fortnight at 5.54% p.a. Total interest payable is $168,500 over 24 years, 11 months.

 

The SMSF's trust deed permits the SMSF Trustee to borrow to acquire the Property. In addition, the SMSF Trustee has reviewed and updated the SMSF's investment strategy to allow this transaction to take place. 

 

The SMSF Trustee approaches the Bank to obtain a limited recourse loan and engages the services of a lawyer to prepare the relevant legal documentation (including the Security Trust deed). 

 

A company is incorporated to act as Security Trustee. The Security Trustee signs the sale and purchase contract and uses funds provided by the SMSF Trustee to pay the deposit of $40,000 on the Property. 

 

At settlement, the SMSF Trustee (using its own funds and the funds borrowed from the financial institution) provides $360,000 to the Security Trustee. The Security Trustee uses the funds to settle on the Property and is consequently registered as the legal owner of the Property. Pursuant to the terms of the Security Trust deed, the SMSF Trustee acquires a beneficial interest in the Property. 

 

Discuss the potential risks of this strategy and make sure you incorporate all the relevant case study facts?