As with any major transaction using SMSF money, there are things to think about well beyond the all-important investment considerations when buying a property.
Firstly, it is important to be really clear about what is being bought and from whom. Remember, only certain assets can be acquired from related parties, the most common in this context being business real property. It is vital to ensure the property is genuinely “used wholly and exclusively in one or more businesses”.
In my experience, accountants and advisers are getting better at spotting the obvious situations where a particular transaction might fall down here, for example, commercial premises incorporating a meaningful residential component that isn’t necessary for the business (such as the classic home-above-the-shop scenario). Situations that still tend to catch people, however, are things like:
- inclusions in the sale contract that are not part of the business real property – for example, fittings (as opposed to fixtures) or business equipment. Both are technically separate assets, even if the parties involved feel they are an integral part of the property, and
- assuming land is business real property simply because it is zoned for commercial use or was previously used as an office or doctor’s surgery, even though it is now a home in a residential area. What matters is the current and intended use.
When the property is being bought from an unrelated party, these complexities don’t arise – the SMSF can acquire pretty much anything as part of a property purchase from unrelated parties.
But the nature of the property does become important again, even under these circumstances, if it is to be rented out to a related party.
Consider a case where an SMSF is buying a property that doesn’t meet the business real property definition from an unrelated third party – perhaps it is a rundown home in a residential area, but the zoning is such that, with a bit of work, it could house a physio practice. As it happens, the SMSF member in this instance is a physio.
At the time the property is purchased, it doesn’t actually matter that it isn’t being used in a business because it’s being purchased from a third party. It’s also fine for the SMSF to pay to renovate the property so that it is suitable for the physio practice (even though, again, it’s not a business real property yet). It is only when it is actually leased to the member’s own business that it becomes important to meet the business real property definition. Otherwise the property will be an in-house asset (and subject to the 5 per cent limit on these assets).
One issue we find people often forget is the fact the property must also be subject to a legally enforceable lease to be exempt from being an in-house asset. There’s no such thing as a handshake deal in an SMSF. And that lease should cover some important issues that are often overlooked in informal or non-existent lease agreements. For example, it should spell out who pays for what. Is there a make-good clause? How will rent be reviewed over time? What happens if there is a problem with the property, such as a flood, that means the member can’t run their business there? Who is responsible for insurance?
And what if the changes made by the SMSF trustee included adding furniture and equipment that suit a physio practice? As mentioned above, these can’t be captured with the property itself as business real property, however, it might still be fine to do so. These assets will be in-house assets, but there is no law against them; they just need to be kept within the 5 per cent limit. Of course, the usual sensible rules apply – they should be leased separately to the member’s business at market rates, with a legally enforceable lease that clearly identifies all parties’ rights and responsibilities.
What if the property in this hypothetical example had been purchased using a limited recourse borrowing arrangement (LRBA)? That might get a little trickier. For a start, the improvements made to get the property ready for the physio practice would have to be paid from the SMSF’s own money, not the borrowings. The trustee would also need to make sure those improvements didn’t fundamentally change the nature of the asset.
If it was simply refitting a home to make it suitable for the physio practice, but fundamentally the property could go back to being a home relatively easily, that’s likely to be fine. But if the changes involved make the home unrecognisable, it’s likely to cross the line into being classified as a completely different asset. That’s something that can’t be done while the LRBA is in place.
Buying a property in an SMSF is a very common transaction. But as it is one with quite nuanced rules, it is precisely the type of transaction on which trustees, accountants and advisers should seek advice before committing. And speaking as an administrator of many property-owning SMSFs, my final suggestion would be to get the paperwork right and in the right order before diving into any weekend auctions.
The calls I dislike most on Monday mornings usually start with: “My client contracted to buy a property on the weekend and they want to buy it in their SMSF. Nope, we’ve not set up the SMSF yet. We thought we’d do that now?”
Meg Heffron is managing director of Heffron.