Buying property in an SMSF Q&As: Part 1

Q: Can you live in a property owned by an SMSF when you retire?

The short answer is no, not while the property remains an asset of the self-managed super fund.

There are two main rules that apply in these situations:

1. The sole purpose test: This requires that all activities carried out by the fund (trustees) are for the sole purpose of providing retirement benefits to the fund members; that the fund assets and resources should not be used to provide a pre-retirement benefit to the members of the fund, or their related parties.
2. The in-house assets test: This test applies a 5% limit on all in-house assets held in a SMSF. In-house assets include assets owned by a SMSF that are leased to a related party unless a specific exception applies.

Living in a property owned by your SMSF would be in breach of the sole purpose test and would in most all cases, exceed the in-house limits.

However, if the property is removed from the SMSF and therefore no longer an asset of the fund, you could then live in the property.

This could be achieved by either buying the property from the SMSF (at market value) or by transferring the property out of the fund as a member benefit payment at a time when you are allowed to access your super benefits, for instance when you are retired.

Q: Can you rent an SMSF property to your children to live in, where they pay the market rate rent for the property?

The same two issues that were covered in the previous question would apply here, being the sole purpose test and the in-house assets test.

There would be an issue with the sole purpose test.

Also, if you consider how the in-house assets test operates, it would be extremely rare for the 5% limit to be satisfied as the market value of the property needs to be used in the calculation of the in-house assets test limits.

For example, a property with a market value of $800,000 would only fit in with the 5% in-house assets limit where the total SMSF assets are above $16 million!

It is important to note that where the value of a fund’s in-house assets exceeds 5% at the end of the financial year, the fund trustees would be required to put in place a written plan to DISPOSE OF (sell) one or more of the fund’s in-house assets to get back below the 5% level. 

Merely kicking the kids out of the property would not work, as the legislation requires the sale of an in-house asset. 

So, renting an SMSF owned residential property to a related party could result in the need for the SMSF to sell the property the following financial year.

Q: My SMSF owns an apartment on the Gold Coast, and we would like to holiday there for a few weeks each year. Do we need to pay rent while we stay?

Again, the same issues covered in the first two questions would apply.

If no rent is paid, then there is a clear breach of the sole purpose test.

If market rate rent is paid, then you would in almost all cases breach the 5% in-house assets test. Remember it is the value of the property that is used in determining the 5% limits NOT the amount of the rent that is paid.

Again, keep in mind the rules around the compulsory sale of in-house assets in the following financial year where the 5% test is failed. Those few weeks on the Gold Coast could end up as an extremely expensive holiday!

Q: Can you personally borrow from a bank and then on lend to an SMSF under a limited recourse borrowing arrangement?

There was a lot of discussion on this issue a few years ago when it became increasingly more difficult to find a bank willing to lend to an SMSF under a limited recourse borrowing arrangement (LRBA).

It was not uncommon to read about SMSF members going to a bank, borrowing personally and then on lending those amounts to their SMSF; essentially becoming the LRBA financier.

If this is done appropriately, it can work.

However, one of the most common issues that arose with these arrangements was where the bank took security over the property being acquired under the SMSF LRBA. Remember, the bank loan in these arrangements is to the individual and not the SMSF.

The result would be a charge over the asset being acquired by the SMSF under an LRBA that does not relate to the actual SMSF loan; instead it is related to the personal loan from the bank. This would mean that the overall borrowing arrangement in place would no longer comply with the strict SMSF borrowing rules and could result in the need to unwind the entire borrowing arrangement. 

Also keep in mind that where a related party loan is used by an SMSF to acquire an asset under an LRBA, it is important that all terms and conditions of the loan are entered into and maintained on an arm’s length basis. If not, all income generated from the asset acquired under the LRBA as well as any associated capital gain would be taxed at 45% instead of the usual 15% super tax rate.

The ATO provides a list of the accepted terms and rates within a practical compliance guide, PCG 2016/5.

Q: We borrowed to buy a property in our SMSF in 2015 and we have paid off more than half the loan already. Can we now borrow to buy another property inside the bare trust?

The SMSF borrowing rules only allow a “single acquirable asset” to be acquired under a borrowing arrangement. In this case, the property acquired under the 2015 LRBA.

So, if you are looking to borrow again to acquire another property, you will need to establish a new borrowing arrangement.

This will require new paperwork, documentation and custodian arrangements (bare trust etc.) to be set up for any additional asset acquired under a new LRBA.

If you used a corporate trustee (company) for the first property borrowing, that same company could also act as trustee for any further bare trust arrangement. Whether that is appropriate must be determined separately for every arrangement.

Q: Are you allowed to personally purchase a property from your own SMSF?

Yes, an SMSF can sell an asset to a related party of the fund.

Although the superannuation rules restrict the types of assets an SMSF can acquire from a related party, these rules do not restrict the sale from the SMSF.

All aspects of the sale must be entered into and carried out on commercial terms and it would, in most cases, be best to have an independent valuation carried out on the property before the sale.

Q: What types of property can an SMSF buy from a member of the fund?

The superannuation laws restrict an SMSF from acquiring most assets from a related party unless a specific exception applies. These exceptions include business real property that is acquired at market value.

Business real property refers to direct property that is used wholly and exclusively in one or more business.

Examples of business real property include:

• A commercial office space used by a professional to run their business 
• A warehouse or factory used entirely in a business 
• A rural property on which a primary production or farming enterprise is carried out.

It is also important to note that the business being carried out from the property DOES NOT need to be the business of a related party. For example, if you personally owned a warehouse and you rented this to an unrelated person for them to carry out their business, this could meet the requirements to be business real property and allow your SMSF to buy that property from you.

Q: If you borrow to buy a property in an SMSF, can you build a swimming pool on the land after it has been purchased?

There are strict rules around what can be done to a property acquired under a limited recourse borrowing arrangement.

The key restriction is that any improvement made to the property:

• Is not carried out with borrowed money; and
• Does not change the nature of the asset, for example, you can’t turn a single residential property held under an LRBA into three separate townhouses; and
• Does not change the function or use of the property, for example, you can’t turn a residential property held under a LRBA into a restaurant.

The following is a summary of information that has been provided by the ATO in a public ruling on SMSFs and LRBAs:

• The single acquirable asset identified when the LRBA is put in place must continue to be the asset that is held on trust under that LRBA.
• If alterations or additions are made to the asset held under an LRBA and those alterations or additions fundamentally change the character of that asset, this results in a different asset being held on trust under the LRBA.
• If the character of the asset as a whole has fundamentally changed, the exception to the borrowing prohibition ceases to be satisfied.
• While the addition of a swimming pool would be an improvement, the changes would not result in a different asset.

Based on this, if the SMSF had sufficient cash to carry out the swimming pool construction, then this may be allowed.

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