Australians have a love affair with property and this is no more apparent than with SMSFs. The ATO’s June 2021 quarterly statistical report shows that around 15% of SMSF assets are invested in property. However, these statistics include as categories the structures of listed and unlisted trusts, as well as limited recourse borrowing arrangements (LRBAs), but not their underlying assets. Based on real property being a predominant asset of these structures, the exposure of SMSFs to the real property asset category could be as high as 20% or even slightly more. This popular asset class gives rise to a number of compliance considerations, including the structure to use to hold real property.
Initial reviews to conduct
Prior to an SMSF making an investment in property and any other type of asset for that matter, the following steps should be taken:
- Review the SMSF’s trust deed – the deed provides the Trustee’s power as to what they can do, what they are required to do and what they cannot do. Once you establish what the trust deed says, you can then apply the law to ascertain whether the proposed action by the trustee will comply.
- Review the SMSF’s investment strategy – it would be prudent for the fund’s Investment Strategy to be reviewed either prior to or at the time of consideration of the proposed property acquisition. Revision of the strategy and amendment, if required, to the asset allocation ranges would need to be done prior to the fund’s acquisition of the asset. Further, for an investment in property, the strategy should specifically consider the factors in SIS regulation 4.09 to ensure it has addressed the risks associated with the SMSF having a substantial portion of its investments in an illiquid asset.
- Super law prohibition, restrictions or requirements – review the super law to determine whether the proposed asset acquisition is permitted under the law and whether there maybe any requirements to comply with, for example, acquiring business real property from a related party must be done at market value.
Don’t forget the sole purpose test
An overriding requirement for any asset acquired or held by a superannuation fund is the sole purpose test, as outlined in section 62 SIS Act. This is particularly important where the property is being acquired from a related party under the business real property (BRP) exception. Simply ensuring the acquisition complies with the section 66(2)(b) BRP exception and section 71(1)(g) in-house asset exception may not be sufficient. The SMSF should also have evidence to show that the acquisition also meets the sole purpose test.
On this point reference can be made to the ATO’s decision impact statement on the Aussiegolfa case and particularly the following from that statement:
“We do not consider that the case is authority for the proposition that a superannuation fund trustee can never contravene the sole purpose test when leasing an asset to a related party simply because market-value rent is received.
It is the purpose of making and maintaining a fund’s investments that is central to identifying if there is a contravention of the sole purpose test. We note the observations of the court that a collateral purpose, and a contravention of section 62 of the SISA, could well be present if, for example, the circumstances indicated that leasing to a related party had influenced the fund’s investment policy.
For example, in the Commissioner’s view a superannuation fund trustee will contravene the sole purpose test if the fund acquires residential premises for the collateral purpose of leasing the premises to an associate of the fund, even where the associate pays rent at market value.”
Whilst this statement concerned the Aussiegolfa case and particularly the leasing of residential property to a related party, consider the circumstances where an SMSF acquires, either from a related party or an unrelated party, a commercial premise that suits the needs of a related busines, to which the premises are leased. What evidence would the SMSF trustee(s) have obtained to show that the leasing of the premises to the related party did not influence their decision to acquire that property? Without such evidence it could be argued that the SMSF acquired the property for the purpose of meeting the needs of the related business, contrary to the sole purpose test.
Also, where an SMSF amends its investment strategy, by disposing of existing fund assets to generate the required cash to acquire the property, it would be prudent for the SMSF trustee(s) to be able to demonstrate how the acquisition of the property is a better investment than the current investment(s) held. Again, particularly if the property is to be leased to a related business.
Make sure the property title is correctly recorded
This is crucial, not just to ensure compliance with SIS regulation 4.09A to keep fund assets separate from trustee personal assets, but also to protect the asset from any future claim in the event of the bankruptcy of a member of the fund, who is also a trustee or director of the corporate trustee or where they are pursued by creditors. Refer to the recently reported case of Frigger v Trenfield (No 10) FCA 1500 which dealt with an SMSF with undischarged bankrupts and what assets were available to creditors and whether certain assets, which were claimed to be assets of their SMSF and so protected, were indeed assets of the SMSF.
An incorrect asset title could also lead to future costs to correct. For example, an SMSF changes from individual trustees to a corporate trustee and when the title is changed for the property, the relevant revenue office states that their records show that the property was never held by the title holders in a trustee capacity, potentially resulting in no duty concessions applying. Depending on the time passed from when then SMSF acquired the property with individual trustees to when the trusteeship changes to a company, there could be challenges in obtaining the relevant documentation to support the premise that the property was held by the individuals in their capacity as trustees of the SMSF, as well has potentially legal costs.
If there is a restriction on holding the property in the name of the SMSF, ownership of the property must still be clearly established. The ATO states that this can be achieved by caveat, or creating an instrument or declaration of trust to enable the SMSF to assert its ownership.
Structures to hold property
There are a number of structures that can be utilised to acquire a property involving an SMSF, members, related and unrelated parties. There is also the Limited Recourse Borrowing Arrangement (LRBA), which requires a specific structure when acquiring property.
Whilst a full analysis of each option cannot be explored in this article, below is a brief outline of each option.
SMSF acquires property outright
For an SMSF that has the cash can acquire an asset outright, the SMSF trustee(s) should address the issues previously outlined. It would also be best practice to ensure all rental property income and expenses are transacted via the SMSF’s bank account.
The SMSF trustee(s) should also ensure that the fund’s property is not used as security for any loans. Where the SMSF has individual trustees and property title registration is only recorded in their names, without reference to the SMSF, the fund’s property could be swept up in a lender’s eagerness to place a charge on personal assets for a loan.
SMSF holds an interest in a property together with a member
Section 71(1)(i) of the SIS Act excludes from the definition of an in-house asset “property owned by the superannuation fund and a related party as tenants in common, other than property subject to a lease or lease arrangement between a trustee of the fund and a related party”. Consequently, an SMSF can have an interest in a residential property with a related party, provided it is not leased to a related party, and that it is owned as tenants in common (Note: that where the property is business real property that it is excluded from the being treated as an in-house asset).
This arrangement, whilst allowing an SMSF to hold an interest in a property together with a member, does not permit the SMSF to increase its interest by acquiring all or part of the interest held by the member, unless the property is BRP. A solution to this issue is provided by the next structuring option.
SMSF holds interest in property via ‘non-geared’ unit trust
A unit trust that complies with the requirements of SIS regulation 13.22C is excluded from being treated as an ‘in-house’ asset. Consequently, the SMSF, together with a member or other related parties, can hold units in the trust, which in turn acquires the property.
This structure offers the advantage, over the tenants in common structure, of the SMSF being able to increase its (indirect) interest in the property, where the property held does not meet the definition of BRP, e.g., residential property.
However, there are strict compliance requirements for a ‘non-geared’ unit trust, as outlined in SIS regulation 13.22C. Further, if any of the events listed in SIS regulation 13.22D occur, the SMSF’s investment in the related unit trust is no longer excluded from the in-house asset rule. This can be costly to deal with as it cannot be rectified.
Holding a property in a ‘non-geared’ unit trust, even where the SMSF holds 100% of the issued units, that is, the SMSF could have acquired it directly, can also provide reduced land tax costs, depending upon the relevant jurisdiction and can also ring fence the property from other assets held directly by the SMSF and may provide some protection from any action against the property asset.
SMSF holds interest in property via unrelated unit trust
The superannuation law prohibits a superannuation fund from holding more than 5% of the market value of assets in ‘in-house assets’. Included in the definition of an ‘in-house asset’ is “an investment in a related trust of the fund”. Consequently, an SMSF can invest in a unit trust that does not meet the definition of a ‘related trust’ and that investment is not treated as an ‘in-house asset’.
Generally, this would require the involvement of unrelated parties, which in turn requires an understanding of when and SMSF ‘controls’ a unit trust. It also requires planning for the situation where unit holders leave the structure which could result in the unrelated unit trust now being a related unit trust and subject to the in-house asset rules.
Limited recourse borrowing arrangement (LRBA)
Section 67A SIS Act enables an SMSF to borrow money under an arrangement, known as a “limited recourse borrowing arrangement” or “LRBA” to purchase a single asset, or a collection of identical assets. The asset is held on trust so that the SMSF trustee acquires a beneficial interest, with a right to acquire legal ownership of the asset, generally once the loan has been repaid. Any recourse that the lender or any other party has under the LRBA against the SMSF trustee is limited to that single fund asset.
The following is a list of other considerations for an SMSF trustee when considering buying property:
Non-arm’s length income (NALI) and expenditure rules – with SMSFs able to acquire BRP from and lease BRP to related parties, transactions need to be on an arm’s length basis otherwise the NALI provisions in section 295-550 ITAA 1997 may apply and tax such income at the top marginal tax rate, currently 45%.
Application of GST – There are special rules for GST in relation to an SMSF. Focusing on property, GST will generally only be relevant where the SMSF is registered or required to be registered for GST and the property held by the SMSF is:
- ‘commercial property’ for GST purposes;
- ‘new residential property’ for GST purposes;
- ‘vacant land’.
Importantly, when an SMSF is acquiring property or selling property, consideration should be given to any potential GST consequences of the transaction.
Annual compliance and audit requirements – Prior to acquiring an interest in property either directly or via an interposed entity, it would be prudent to inform SMSF trustees of the compliance and audit requirements for the property asset category so that they are aware of the potential audit requests. This could require the same issue being addressed each income year, for example:
- The market value of the property or units in the unit trust at each 30 June;
- Showing that the unit trust continues to satisfy the requirements of a ‘non-geared’ unit trust and no events outlined in SIS regulation 13.22D have occurred;
- Where the property is not BRP, that it has not been used by a related party, particularly if it’s located in a popular holiday destination;
- No charge is held over the property, except as permitted for an LRBA.
Dealing with the death of an SMSF member – SIS regulation 6.21 requires a deceased member’s benefit to be cashed as soon as practicable. An SMSF that has a significant portion of assets in property can present a challenge to meet this requirement. Prior to the introduction of the transfer balance cap (TBC), a death benefit income stream was a common approach, however, the TBC may restrict this strategy.
There are many compliance, tax and practical issues associated with an SMSF investing in real estate. Understanding these and applying them to your SMSF clients will contribute to property being a successful part of the fund’s investment portfolio. These can be achieved through education, whether it be the adviser, accountant or administration undertaking such education or those same persons providing it to their SMSF clients.
It’s noted that the article has not covered property development in an SMSF – that’s for another time……
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