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In this newsletter, we will briefly discuss how your SMSF can acquire real estate for long-term growth. There are many options—either through direct investment or via investment in special purpose entities, with or without related parties, which can hold real estate.
There are certain prohibitions against acquiring residential properties from related parties; however, if you own business-use property, your SMSF can purchase it from you as long as the transaction is conducted at market value.
Your SMSF can also borrow to acquire a property, as long as this borrowing is included in your investment strategy and your trust deed allows this type of borrowing, commonly known as Limited Recourse Borrowing Arrangements (LRBAs).
Before you embark on any strategy, you should be careful of non-arm's length dealings with your SMSF, where the SMSF receives more income than it should. Income is taxed in super at 15%, but all non-arm's length income (NALI) is taxed at the highest marginal tax rate.
Any income derived by the SMSF from a non-fixed trust, such as a discretionary trust, is generally always considered NALI, whereas investment income from a related company or fixed trust is always tested for NALI issues.
On the flip side, you should also be aware of NALE (non-arm's length expenditure), where the trustees of the SMSF either underpay for acquiring an asset or underpay or do not pay for goods and services. If found breaching this rule, the SMSF can be taxed at 90% on the income.
SMSF as Direct Owner
Instead of paying you to acquire your business-use- property, the SMSF can also accept the market value of the property as a concessional or non-concessional contribution for the member.
Concessional contributions cap amount is $30,000 per member per year, however if you decide to use up to five years of unused cap (provided you have less than $500K in super) for each member, you can contribute a staggering amount of concessional contributions in form of property and claim a tax deduction for these contributions.
You can also utilize your Non-concessional cap amount of $120,000 if your total super balance is below $1.9M or even benefit from bring-forward rules where you bring forward next two years contributions and contribute up to $360,000 provided you have less than $1.66M in super.
When you sell your business-use property to your SMSF, there is no stamp duty paid by your SMSF if the property is allocated to your account (VIC, NSW & WA). What is important is that the transaction should be done at market value — the SMSF either pays you cash, or the asset is treated as a contribution, or a mix of both.
Please note that you could pay Capital Gains Tax, subject to the 50% discount if you have owned the property for over 12 months. Selling could be a good strategy if you have a capital loss which you want to offset. However, you should be watchful of GST, as the SMSF must be registered for GST. If you or your business occupies the business-use property, you must then pay market rent to your SMSF.
SMSF as In-Direct Owner
SMSF can invest in property
- With co-investors (related or unrelated)
- Investment in an Unrelated Geared Unit Trust
- With Borrowing (Bare Trustee is owner)
As a Co-Investor
The most popular way to invest with the SMSF is via a fixed unit trust structure with no borrowings — Tenants in Common.
In this structure, your SMSF and any unrelated or related party can purchase units in a Fixed Unit Trust (FUT) in any proportion — including you or your SMSF having a controlling interest in the Fixed Unit Trust. Business Real Property (exclusively for business use) purchased by this trust can be leased to a related party.
This investment by the SMSF is not an in-house asset as long as the FUT does not borrow, invest in, or lend to another entity. There should be no charge on the property held by the FUT. One big advantage of this structure is that, in the future, if the SMSF has more cash, it can purchase units owned by related parties at market value, and depending on the value, no stamp duty may be payable.
A major disadvantage is that the only activity of the FUT is to hold the asset; conducting a business is not allowed. If there is any borrowing, the whole structure must be dismantled, as the unit trust would then become an in-house asset of the SMSF.
Unrelated Geared Unit Trust
As long as the SMSF does not have a controlling interest in the Unit Trust, it will be treated as an “Unrelated Trust.” This control can be either direct— by owning more than 50% of the units—or indirect, through members of the fund, their relatives, or business associates of the members.
In this situation, the Unit Trust is able to borrow, conduct a property development business, and place a charge on its assets, and the investment by the SMSF will not be considered an in-house asset of the fund.
The SMSF must ensure that it does not control 50% or more of the units, either alone or together with relatives or business partners. This is typically a
syndicate-style investment involving other unrelated parties. There is no control over the activities of the trust, and in the case of an unlisted unit trust, exiting the investment is often only possible as stipulated in the unit holders' agreement.
Property Custodian Trust
SMSFs can borrow to purchase a single acquirable asset. This property can be leased to a related party if it qualifies as Business Real Property (BRP), provided it is leased at market rent. The bank can place a charge over the asset, and all rent must be paid to the SMSF. The SMSF can also borrow from a related party.
In case of default, the lender has recourse only on the asset; however, to cover themselves, most lenders take personal guarantees from members of the fund.
This type of borrowing is ideal where the SMSF members want to purchase a BRP for their own use and have a reliable tenant — which is their business.
Another use of this borrowing is where a Trustee purchases a retirement home at today's prices and then buys the property from the SMSF when they retire and enter the pension phase, which generally occurs when they are over 60 years old and cease full- time work. When the SMSF sells the property, it pays no tax as the fund is in pension phase. However, subject to state rules (exempt in VIC and WA), stamp duty may be payable by the member, provided they were members of the fund when the fund purchased the property.
It is also possible for members or related parties, such as a bucket company, to lend to the SMSF. The SMSF can then borrow to buy units in a FUT instead of purchasing property directly, for example. There are many ways to skin a cat — but super rules are very strict. We strongly suggest you call our office before taking any action, to avoid breaching any legislation.
