For many small businesses and professional firms, one of the great benefits of an SMSF is your fund can take out a loan to buy the commercial property used by your business and you become your own landlord.
But like all things with super, there are plenty of rules you need to follow.
So, here’s a simple 10-step guide to organising an SMSF commercial property loan and rental arrangement that keeps the ATO on side.
What are the rules for SMSF property loans?
You can only invest in a property asset through your SMSF if you strictly comply with the ATO’s rules. The property investment must:
- Comply with the sole purpose test to provide retirement benefits to fund members
- Not be acquired from a related party of a member
- Not be lived in by a fund member or related party of a fund member
- Not be rented by a fund member or related party of a fund member.
Commercial property investments, however, are exempt from the in-house assets and related party acquisition rules. These exemptions for commercial property mean your SMSF can take out a loan to purchase your business premises and your business then pays rent to your SMSF.
For more about SMSF borrowing, read SuperGuide What are the SMSF borrowing rules? and SMSF investment rules: What every trustee should know.
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Need to know
The legislation permitting SMSFs to borrow to acquire a property asset requires the loan to be a limited recourse borrowing arrangement (LRBA).
Under an LRBA, the property is provided as security for the loan, but the lender does not have recourse to other fund assets if the loan is not repaid.
The SMSF borrowing rules require the property asset to be held by a separate entity called a bare trust.
The SMSF is the beneficiary of the trust, but the bare trustee (which cannot be the same as the SMSF trustee), acts as the registered holder of the property.
When the loan is repaid, legal ownership of the property reverts to the SMSF trustee.
How to purchase a commercial property for your SMSF
Borrowing to buy a commercial property through your SMSF and leasing it back to your business is similar to a normal property purchase. There are some important steps you need to follow, however, to ensure you don’t fall foul of the super and tax rules:
Step 1 – Check your investment strategy and trust deed
If you are thinking about borrowing to invest in a commercial property for your SMSF, you should check the fund’s investment strategy prior to buying. The asset must fit within the investment strategy, particularly in relation to asset diversification, liquidity and maximisation of returns to fund members.
Also check that the fund’s trust deed permits it to purchase property and implement a borrowing arrangement.
Step 2 – Check it’s business real property
To be exempt from the normal in-house asset and related party acquisition rules, a commercial property investment must meet the ATO’s definition of business real property. The ATO generally defines land and buildings used wholly and exclusively in a business – and which satisfy the business use test – as business real property.
Under the business use test, the property must be “used wholly and exclusively in one or more businesses” carried on by an entity. It can be a commercial or industrial property, office, warehouse, shop or farm.
If the asset is a farm used for primary production, it can still meet the test of being used wholly and exclusively in a business if it contains a dwelling used for private or domestic purposes. The dwelling, however, must be an area of land no more than two hectares and the main use of the property must not be for domestic or private purposes.
Step 3 – Review the property asset rules
If you use an LRBA to purchase a commercial property, the asset must be a single acquirable asset (or collection of identical assets with the same market value).
Properties on multiple titles (such as a commercial premises with a car park on a separate title), require a bare trust for each title if they can be sold independently.
The ATO rules also prohibit alterations that change the character of the property until the loan is paid off, so major renovations are not permitted. If improvements are made to the property, you are not permitted to use borrowed funds, they must be paid for using money from the SMSF.
Need to know
Under the sole purpose rules, any investments made by the SMSF must be for the benefit of the fund members, not for the convenience of your business.
Step 4 – Organise a bare trust
If your SMSF is taking out a loan for the purchase, you need to set up a bare trust with the SMSF as its beneficiary. Bare trusts act as the registered holder of the property on behalf of the SMSF until the loan is repaid.
The trustee of the SMSF cannot be the same as the trustee of the bare trust. Some lenders require a bare trust to have a corporate trustee.
Need to know
It’s important to get legal advice when setting up a bare trust for an LRBA, as different states have different rules and there can be stamp duty implications if it is not done correctly.
Step 5 – Check the fees and costs
As with any investment, there are fees and costs involved when buying a commercial property. These can include upfront fees, legal fees, advice fees, stamp duty, on-going property management fees, bank fees, loan fees and rates. There are also ongoing expenses such as strata and property management fees to consider.
Lenders generally offer loans for an LRBA at a higher interest rate than for residential property or loans outside the super system, and they are usually only willing to loan up to 70–80% of the purchase price. This means the SMSF must have sufficient money available to pay the deposit.
It’s worth comparing interest rates and conditions for SMSF loans, as these can vary considerably.
Need to know
Some lenders restrict the loan amount available for an LRBA if the SMSF has individual trustees rather than a corporate trustee. Lenders may even require both the SMSF and bare trust to have corporate trustees.
Step 6 – Prepare a contract of sale
If you enter into a contract of sale to purchase a commercial property, ensure the contract states the purchaser is the trustee of the bare trust. (Some states require the name of both the bare trustee and SMSF to be listed.)
The trustee of the bare trust must be the registered owner at settlement and must be listed on the certificate of title. Failure to purchase the property in the correct name can lead to expensive stamp duty implications in some states if the contract is executed in the wrong name.
Need to know
Money borrowed under an LRBA cannot be used to refinance or improve an existing super fund property asset. Borrowings can only be used to acquire a new single asset.
Step 7 – Submit a loan application
Organising an SMSF loan can take time, as you will be required to submit detailed documentation and the lender will carefully assess this before offering a loan facility.
Most lenders require copies of the trust deeds for both the SMSF and bare trust, tax returns for the SMSF, evidence of the rental income and a full copy of the proposed contract of sale.
They may also check the financial position of fund members, or require proof of their income, if future super contributions will be required to help top-up the loan repayments.
Need to know
Many lenders require personal guarantees for LRBA loans, as the non-recourse nature of the loan arrangement means they cannot sell the assets of the SMSF to recover their money.
If the property is sold and the loan is not repaid in full, the lender may seek to recover money from your personal assets if the contract includes a personal guarantee.
Step 8 – Purchase the property
Before signing the contract of sale, ensure you obtain legal and accounting advice, as there can be significant stamp duty implications in relation to the order in which the documentation is signed.
The bare trustee signs the contract of sale as the legal purchaser of the commercial property and is listed on the title deed as the registered owner.
Step 9 – Organise a commercial lease
To demonstrate to the ATO that a normal ‘arm’s length’ business relationship exists between your company and the property owner (the bare trustee), it’s sensible to sign a registered commercial lease if your business plans to rent the property.
The lease must charge market rent and be in line with terms and conditions in a typical commercial lease. All rental payments must be paid as outlined in the lease arrangement, with no discounts or concessions. Rental must be paid promptly and in full on the due date as if your business was renting from a private landlord.
If rent from the lease doesn’t cover the LRBA loan repayments, the SMSF will need to make up the difference from super contributions.
Step 10 – Transfer the title to your SMFS
Once the LRBA loan has been paid off, the property title can be transferred to the SMSF from the bare trust. This can usually be done without incurring taxes and other liabilities, provided the LRBA was set up appropriately.
For more on SMSF investing, read SuperGuide articles:
- What on earth is an in-specie transfer?
- The arm’s length rule for SMSFs
- How to create an SMSF investment strategy (including examples)
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