While a lot of attention is given to acquiring an SMSF property via a limited recourse borrowing arrangement, there are many other ways to achieve this goal. Tim Miller looks at some alternative approaches trustees can use to make a property purchase.
A key aspect of using SMSFs for retirement planning purposes is the ability to use the fund to acquire direct property assets. This can include:
- business real property (whether or not acquired from a related party), and
- other direct property investments (acquired from parties unrelated to the SMSF).
For SMSF trustees, business real property is the only type of real property that can be directly acquired from a related party. As a result, the focus for SMSF direct property investments has historically been business real property. However, residential investment properties are more and more on the radar for many trustees, helping them fulfil the ‘Australian dream’ of owning property.
What is a focus for trustees is determining how to acquire property. With so much attention on the use of limited recourse borrowing arrangements (LRBA) since their introduction in September 2007, we often overlook the opportunities that have been available to trustees since 1999, and indeed before.
Business real property investment
The ability for SMSFs to invest in business real property has been an area of keen interest since the introduction of the Superannuation Legislation Amendment Act (No 4) 1999, which allowed funds with fewer than five members to use up to 100 per cent of fund assets to acquire business real property.
Key benefits of SMSF investment in business real property include the general benefits of investment in a growth asset providing a regular commercial rate of rental income and the fact the business proprietors do not have to relinquish control of their business premises to a third party.
Where an SMSF is considering a business real property transaction, it is important to ensure:
- all transactions, including ongoing rental payments, are conducted at arm’s length and are well documented,
- the property is always maintained as business real property and the SMSF is not seen as running a business,
- any development work undertaken/paid for by the SMSF is considered part of the business property investment,
- sufficient cash flow exists within the SMSF to manage all property assets on an ongoing basis,
- a plan is in place to meet future benefit payments as and when they arise, particularly where a high property component exists within the SMSF, and
- all investments are part of the fund’s documented investment strategy.
Contributions caps considerations
Prior to the introduction of the current contributions caps, the in-specie contribution of business real property had been a strategy that enabled members to generate a rapid increase in the value of total SMSF assets. While this strategy will continue to be relevant in certain client circumstances, it must now be considered in light of the contributions caps restrictions.
For example, for an individual fund member under 65, the maximum non-concessional contribution that can be made in any financial year is limited to $450,000, based on the application of the three-year bring-forward provisions. This amount will rise to $540,000 from 1 July 2014, subject to the bring-forward not being triggered in either 2012/13 or 2013/14.
Where it is possible for the transfer to occur in respect of more than one individual (such as a member and their spouse), this limit may increase to $900,000 ($1.08 million from 1 July 2014). In certain cases even these higher limits will restrict the ability to make large property injections directly into a superannuation fund.
Other contributions, such as capital gains tax (CGT) concessional contributions, may be beneficial, however, the Australian Taxation Office has given a fair indication that an asset sold subject to the small business CGT concession is unlikely to also meet the timing requirements to be transferred to a fund under the concession.
Other direct property investments
Where direct property investments, other than business real property, are used under SMSF arrangements, many of the issues outlined above will again need to be considered.
Additional considerations will also be required on the basis that other direct property investments are ineligible for the in-house asset and acquisition of asset exceptions that apply for business real property. Such property cannot be acquired if owned by members or related parties.
Alternative property investment options – partial acquisition
Another area in which care must be taken is where an SMSF wishes to purchase a property jointly with other related parties. This may arise for a number of reasons, including:
the need for personal borrowings (unrelated to the property being purchased) to be used in the partial funding of a property acquisition, or
the application of the contributions caps to limit the amount of an in-specie property contribution that may be made at a particular time.
In particular, in the event a direct property investment is to be purchased jointly with other parties, the manner in which ownership is structured should be carefully considered. This includes the careful consideration of tenants-in-common arrangements or the use of non-geared unit trusts.
Tenants-in-common arrangements
Although tenants-in-common arrangements can be used to facilitate the partial acquisition of direct property investments, the use of this ownership structure must be very carefully considered for the following reasons:
if the underlying direct property investment is not, or does not remain, consistent with the business real property definition, the SMSF will not be able to:
lease the property to a related party, or
subsequently acquire the remaining share of the property from a related party,
a partial share of a property held on the basis of tenants-in-common is likely to be extremely difficult to sell to an unrelated party, and
any change in the ownership of the direct property investment may have CGT, goods and services tax and stamp duty implications.
Non-geared unit trusts
Non-geared unit trusts are attracting increasing attention in facilitating partial direct property investments that may subsequently be acquired by the SMSF over time. Alternatively, they are being used by a fund that acquires 100 per cent of the units and then subsequently transfers those units back to related parties over time as an intergenerational asset retention strategy.
The current contributions caps have increased the focus on this type of arrangement by restricting the amount of lump sum contributions that may be made in any particular financial year. Likewise, reluctance by some to borrow within the superannuation environment has meant trustees are looking for alternative options.
Properly structured non-geared unit trusts are eligible for:
- a general exemption under the in-house assets provisions, and
- an exemption under the acquisition of asset provisions, which is extremely powerful.
Accordingly non-geared unit trusts can represent effective vehicles for the partial acquisition of direct property investments held in conjunction with related parties. In particular, non-geared unit trusts can effectively cater for the subsequent transfer of additional property ownership to the SMSF, via the acquisition of additional units in the non-geared unit trust, without any change in ownership of the underlying direct property investment. Consideration will need to be given to the possibility of CGT and stamp duty implications in regards to the transfer of units.
The policy objective behind the use of non-geared unit trusts was to increase flexibility in the way business real property could be held by a fund with less than five members.
It broadened the way an SMSF could hold business real property from direct only to direct, via a company or via a trust. The regulations provide for investments in non-geared companies or trusts, however, in most instances these structures take the appearance of a trust rather than a company, but both are possible.
Trust requirements
Regulation 13.22c of the Superannuation Industry (Supervision) (SIS) Regulations, which relates to investments in a related trust post 28 June 2000, ensures certain investments of a superannuation fund are excluded from the meaning of in-house asset if they satisfy the following conditions:
- the trust does not borrow,
- there is no charge over an asset of the trust,
- the trust does not invest in or loan money to individuals or other entities (other than deposits with authorised deposit-taking institutions),
- the trust has not acquired an asset from a related party of the superannuation fund (after 11 August 1999) other than business real property acquired at market value,
- the trust had not acquired an asset (apart from business real property acquired at market value) that had been owned by a related party of the super fund in the previous three years (not including any period of ownership prior to 11 August 1999),
- the trust does not, directly or indirectly, lease assets to related parties, other than business real property,
- the trust does not conduct a business, and
- the trust conducts all transactions on an arm’s-length basis.
Therefore, investing in shares is not permitted. In practice this means non-geared unit trusts are generally only effective for funds wishing to hold direct tangible assets. Interestingly, furniture and equipment can be owned, but not if they are rented to a related party, not even for business purposes, as they are not business real property.
There is no restriction on an SMSF acquiring further units from a related party, even if the underlying asset of the trust isn’t business real property, so long as the asset of the trust was not acquired from a related party.
Failure to satisfy the requirements
A fund will lose the in-house asset exemption for that particular trust if the trust:
- acquires an interest in another entity,
- makes a loan to another entity, unless the loan is a deposit with an authorised deposit-taking institution,
- gives a charge, or allows a charge to be given, over, or in relation to, a unit trust asset,
- borrows money,
- conducts a business,
- becomes a party, either directly or indirectly, to a lease arrangement involving a related party of the fund that does not involve business real property,
- conducts a transaction other than on an arm’s-length basis,
- acquires an asset (other than business real property acquired at market value) from a related party of the fund, or
- acquires an asset (other than business real property acquired at market value) from any party if the asset had been an asset of a related party of the fund since the later of:
- the end of 11 August 1999, or
- the day three years before the day on which the asset was acquired by the fund.
If the number of members in the fund increases to five or more, then all companies or trusts subject to the in-house asset exemption will lose the exemption shelter.
Taxpayer alert TA 2012/7 warns taxpayers about entering into property acquisition transactions that contravene superannuation law with a focus on the use of 13.22c trusts.
All investments, whether held directly or via a related or unrelated entity must still be made in accordance with an appropriately formulated investment strategy and in satisfaction of the sole purpose test.
