Property can be an attractive long-term investment for a self-managed superannuation fund (SMSF), but the rules are very different from buying property personally or through a family trust.
The key issue is not simply whether the investment looks financially sensible. SMSF trustees must also ensure the purchase, financing and ongoing use of the property comply with the superannuation rules.
1. Start with the SMSF’s investment strategy
An SMSF exists to provide retirement benefits for its members. Property should therefore fit within the fund’s documented investment strategy, having regard to matters such as risk, return, diversification, liquidity and the fund’s ability to meet liabilities.
A property purchase can tie up a large portion of an SMSF’s assets. Trustees should consider whether the fund will still have enough cash to meet tax, administration costs, insurance, loan repayments and benefit payments when required.
The investment strategy should reflect the fund’s actual position rather than simply being a standard document that is never revisited.
2. Related-party use can create serious problems
SMSF property needs to be kept clearly separate from the personal affairs of members and related parties.
Residential property held directly by an SMSF and leased to a member or related party is likely to raise in-house asset and sole-purpose issues. In practice, residential SMSF property should generally be treated as a genuine arm’s-length investment for unrelated tenants.
Business real property is different. Subject to the detailed rules, an SMSF may be able to acquire qualifying business real property from a related party at market value or lease qualifying business premises to a related business.
The distinction can be important. A property being physically designed as a house does not necessarily decide whether it is business real property; the actual use of the property is relevant.
3. Borrowing through an SMSF requires a specific structure
SMSFs are generally prohibited from borrowing, but a limited recourse borrowing arrangement (LRBA) is one of the main exceptions.
Under an LRBA, borrowed money is generally used to acquire a single acquirable asset. The legal title is normally held in a separate holding trust while the SMSF holds the beneficial interest. Once the borrowing is repaid, the SMSF can obtain legal title.
This structure needs to be established correctly before the transaction is committed.
A common mistake is signing a property contract first and trying to fix the SMSF borrowing structure afterwards. That can create legal, duty, finance and superannuation compliance problems.
If an SMSF is going to borrow, the trustee should obtain advice before signing the purchase contract.
4. Related-party loans are possible, but the terms matter
The lender under an LRBA does not necessarily have to be a bank. A related party may lend to an SMSF.
However, the arrangement must be considered carefully. The ATO scrutinises related-party LRBAs where the loan terms or the way the loan operates are inconsistent with what parties dealing at arm’s length would ordinarily accept.
Interest rate, repayment terms, security, loan-to-value ratio and documentation can all matter.
A related-party loan should not be treated as an informal family arrangement simply because the lender and members know each other.
5. Improvements and development require care
An LRBA can generally fund the acquisition of a single acquirable asset and certain costs connected with the acquisition. The rules distinguish between repairing or maintaining an asset and improving it.
This becomes particularly important where trustees intend to renovate, substantially improve or develop the property.
For example, a strategy involving vacant land and construction, multiple titles, subdivision or major redevelopment can raise issues that do not arise with a straightforward purchase of an established property.
The structure should be reviewed before committing to the project, not after work has commenced.
6. All dealings should be on commercial terms
SMSF transactions should be conducted on an arm’s-length basis.
That means trustees should be able to support matters such as:
- the purchase price
- rent charged
- interest rate on related-party finance
- expenses paid by the fund
- property management arrangements
- any transaction involving a member, relative or related business.
Independent valuations and properly documented agreements can be particularly important where related parties are involved.
7. Consider the full cost, not only the tax rate
SMSFs can receive concessional tax treatment, but tax should not be the only reason for buying property through super.
Trustees should also consider:
- establishment and ongoing administration costs
- SMSF accounting and annual audit costs
- legal and holding trust costs where borrowing is involved
- finance costs and loan restrictions
- land tax and state-based issues
- cash flow and liquidity
- insurance
- diversification
- the fund’s longer-term retirement strategy.
A property that makes sense personally may not necessarily make sense inside an SMSF.
Before you sign a property contract
For an SMSF property purchase, it is worth confirming the following before committing:
- Is the property consistent with the SMSF investment strategy?
- Will the fund have sufficient liquidity after settlement?
- Is any member or related party involved in the transaction or intended use?
- If borrowing is required, has the LRBA and holding trust structure been reviewed?
- Are the loan and lease terms commercial and properly documented?
- Have the tax, superannuation, legal and state-based consequences been considered?
Getting the structure right before the contract is signed is usually much easier than trying to correct it later.
If you are considering purchasing property through an SMSF, we can assist with the accounting, tax and compliance aspects of the proposed structure and work with your legal and finance advisers where required.