In this guide
One of the attractions of self-managed superannuation funds (SMSFs) for many investors is their ability to invest in direct property.
According to the Australian Taxation Office (ATO), a significant number of SMSFs do indeed invest in direct property. As at December 2024, approximately 11.2% of all SMSF assets were invested in non-residential property (approximately $110 billion) and another 6% (approximately $58 billion) were invested in residential property.
Although it has its benefits, investing in property in an SMSF can be complicated and should never be considered as an easy way to enter the property market.
The rules
Just like any other asset in which an SMSF invests, and perhaps even more so if the property asset is to represent a large chunk of the SMSF portfolio, a property needs to meet the sole purpose test.
That means the SMSF, and therefore the investments it invests in, need to be maintained for the sole purpose of providing the members (and their dependents on the member’s death) with retirement benefits.
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There are some exceptions for SMSFs around incidental benefits, as stated in the below extract from SMSFR 2008/2 ruling.
Nevertheless, the provision by an SMSF of benefits other than those specified in subsection 62(1) that are incidental, remote or insignificant does not of itself displace an assessment that the trustee has not contravened the sole purpose test. As set out at paragraph 5 of this Ruling, determining whether benefits are incidental, remote or insignificant requires the circumstances surrounding the SMSF’s maintenance to be viewed holistically and objectively.
Related parties and in-house assets
If you are considering acquiring a property in your SMSF from a related party, there are very specific conditions that must be met. You can only acquire a property that meets the requirements to be business real property, a property used wholly and exclusively in one or more businesses and only at market rates.
Related parties include:
- The members of the fund
- The relatives of each member
- The partners and/or business partners of each member
- Any spouse or child of those partners
- Any company the member or their associates control or influence
- Any trust the member or their associates control
- An employer who is required to contribute to a super fund based on a written agreement with the trustee (this would not usually be relevant for SMSFs).
The exceptions to these rules include acquiring business real property. Business real property is defined as land and building that is used wholly and exclusively in a business. It can apply to agricultural property in some instances, even if there is a residential home on the property, provided the dwelling is in an area of land no more than two hectares and the main use of the whole property is not for domestic or private purposes.
Related parties and SMSF members are also able to rent or lease business real property from SMSFs, so long as the lease is entered into and then maintained at commercial rates, that is, an arm’s-length arrangement.
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Direct property
As the ATO statistics illustrate, a significant percentage of SMSF assets are invested in direct commercial property (or business real property) and direct residential property.
Residential investment property includes houses and apartments that provide rental income for the SMSF.
Like all investments by an SMSF, as well as meeting the sole purpose and related party tests, direct property investment needs to be explained and justified in the fund’s investment strategy.
Business real property
Business real property is an exception to the in-house assets and related party acquisition rules, meaning it can make up more than 5% of your fund and it can be acquired from, for example, your business. For business owners that also have an SMSF, acquiring their business premise in their SMSF (at market rates), and leasing it back to the business (also at market rates), can present a real financial advantage.
The land or property being acquired must satisfy the ‘business use test’, which means it must be ‘used wholly and exclusively in one or more business’ carried on by an entity. A farm, with a residence as part of it, can meet this definition if it is being used for primary production (not domestic or private purposes) and if the dwelling has an area of land no more than two hectares.
The ATO uses the following example of how the definition of commercial property is applied.
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Other kinds of property
SMSFs can also invest in property via property trusts, which can be listed or unlisted. Listed property trusts (LPTs) and real estate investment trusts (REITs) are listed on the Australian (or international) stock exchanges and SMSFs can invest in them as long as they comply with their investment strategy. LPTs and REITs invest in many property types including office, commercial, industrial, healthcare and occasionally residential.
Unlisted property trusts are investment trusts that invest in property directly and can give investors exposure to large commercial properties that they wouldn’t have been able to own individually. For SMSFs, investments are accessed via a fund structure and come with the same kinds of fees and minimum investments as most managed funds.
ATO concerns and drawbacks
Spruikers have taken advantage of Australians’ love affair with property for years and often promote SMSFs as a means to invest in property.
These operators may be less blatant now, but the ATO has again raised concerns around property and ‘one-stop shops’.
After the Australian Securities and Investments Commission (ASIC) released two reports on the sector – report 575 and report 576 Member experiences with self-managed superannuation funds – the ATO said: “The interviews also identified a growing use of ‘one-stop shops’ where the adviser has a relationship with a developer or a real estate agent whose products the person is encouraged to invest in. This put people at increased risk of getting poor advice that did not take account of their personal circumstances or is not given in their best interests.”
Since then, these one-stop shops have been under increased scrutiny by ASIC and the ATO. The two regulators are now sharing data and intelligence, and ASIC is taking enforcement action where it sees unscrupulous behaviour.
So, if you are considering establishing, or have been advised to establish, an SMSF just to invest in residential property, you should consider getting independent financial advice.
Borrowing to invest in property
Because of the size of the asset, property investing in an SMSF is generally done via a borrowing arrangement specific to SMSFs, called a limited recourse borrowing arrangement (LRBA).
An SMSF can take out a loan to buy an asset in their SMSF if it is a ‘single acquirable asset’ (or collection of identical assets with the same market value). The asset purchased via the LRBA must be held in a separate bare/holding trust. The LRBA structure protects the SMSF from being responsible for anything other than the asset in the bare trust.
CGT relief
If your SMSF sells a property asset, you must include any net capital gains in the fund’s assessable income. However, there is a capital gains tax (CGT) discount of one-third if the property has been owned for over a year.
If your SMSF is entirely in the pension or retirement phase when the property is disposed of, then the fund may not need to pay any tax at all on the capital gain.
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