Self-managed superannuation funds (SMSFs) are commonly used to purchase property. The superannuation environment provides a concessional tax environment on earnings and capital gains, so many find it attractive to invest in a specific property using their accumulated superannuation balance.
There are however a range of specific rules that need to be considered before acquiring assets, with two that generally require specific consideration for property investments being:
- Sole purpose test – essentially this requires assets to be held for the sole purpose of providing retirement benefits to members, not pre-retirement benefits
- Investment strategy – it is a legal requirement that trustees consider the actual investment strategy of the SMSF. This must be reviewed regularly and consider risks, diversification, liquidity and whether to hold insurance cover for members. Diversification and liquidity in particular can be an issue for SMSFs investing in property as you generally can't sell part of a property for liquidity.
Residential property cannot generally be purchased or otherwise acquired from a related party, nor can it be leased or used in any capacity by a related party. This rules out things like having a holiday house in the fund, or buying a property for the kids to stay in - even if market rental was paid for such use.
An SMSF may purchase land for development so long as the development does not constitute carrying on a business and excluded assets during the development aren't acquired from related parties. Property development arrangements can be complex and requires careful consideration and planning.
Commercial property investments are a little more flexible, though there are still a range of considerations to take into account. SMSFs can acquire a commercial property from a related party, including a purchase at market value, or an in-specie contribution by a member(s) of the fund, subject to the annual contribution limits. Transfer duty exemptions may be available where the property is transferred in for no consideration, though there may be other income tax considerations to take into account.
Commercial properties can also be leased to a related party, but the trustees will be required to prove that the arrangement is at arm's-length. A written lease must be entered on arm's length terms, and these terms need to be followed - the trustee should be able to demonstrate to the fund's auditors that these requirements have been met. Where rent-relief has been granted because of the COVID-19 pandemic to a related party, it should be able to show it was the same kind of relief which would be granted to an unrelated party.
Where it is intended commercial property or properties make up the majority of the assets of an SMSF, careful consideration should be given to the investment strategy as lumpy assets can create issues with diversification and liquidity
The trustees are required to provide a market valuation of all assets, including property, as at their reporting date of 30 June each year. They may also be required to provide additional mid-year valuations (e.g. where a member wants to roll out their balance, or where pensions commence other than at year end). A formal valuation may not necessarily be required, but the trustees need to show objective and supportable data. In practice, a third-party appraisal or valuation may be required, which may come at additional costs. The trustees are required to arrange these valuations as the auditor cannot perform a valuation on the trustee's behalf.
Borrowing within a SMSF is generally possible but is highly regulated and complex. The borrowing must be done under a 'limited recourse borrowing arrangement' which provides the property is the only asset of the fund available for recourse to the lender. Further, these arrangements require the SMSF to purchase a single acquirable asset, which may preclude, for example, multiple property titles or a property purchased for development purposes. In this structure, the property is held under a bare trust as custodian for the fund until the loan is repaid. This structure may have significant establishment costs and anecdotally, the large banks have recently demonstrated very little appetite for this kind of arrangement. Related-party arrangements are possible, but evidence and support for loan terms are critical in comparison against the ATO published safe harbour rules.
Net income generated by an SMSF will generally be taxed at a concessional 15% tax rate, so long as all compliance requirements are met. Capital gains on assets held over 12 months will receive a third discount with an effective tax rate of 10%. Further tax exemptions may be available if the assets support a member drawing a pension.
Self-Managed Superannuation is an inherently complex area. Moore Australia has access to specialist superannuation tax experts and licensed financial advisors.
The material contained in this publication is in the nature of general comment and information only and is not advice. The material should not be relied upon. Please contact your local Moore Australia office to discuss your specific circumstances or case. Moore Australia, any Australian Member, any related entity of those persons, or any of their officers employees or representatives, will not be liable for any loss or damage arising out of or in connection with the material contained in this publication.