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One of the unique characteristics of self-managed superannuation funds (SMSFs), which make them attractive to some 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 2022, approximately 9.3% of all SMSF assets were invested in non-residential property (approximately $78 billion) and another 5.1% (approximately $43 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.
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, needs to be maintained for the sole purpose of providing the members (and their dependents if the members are deceased) with retirement benefits.
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 from a related party for your SMSF, there are very specific conditions under which you can do so. You can only acquire a property used wholly for business or farming purposes and only at market rates.
To recap, related parties include the below.
- The relatives of each member
- The business partners of each member
- Any spouse or child of those business partners
- Any company the member or their associates control or influence
- Any trust the member or their associates’ control.
Employers who contribute to your superannuation and associates of employers who do so (business partners and companies or trusts the employer controls and companies and trusts that control the employer) are also related parties.
The exceptions to these rules include acquiring business real property. A 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 – if 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.
Other exceptions include acquiring in-house assets – providing the value of the in-house asset does not exceed 5% of your fund’s total assets. That requirement alone rules out residential property for the majority of funds, which would have to be very large for a direct property investment to be less than 5% of total assets.
Related parties and SMSF members are able to rent or lease business and farming property investments from SMSFs but not residential property owned by SMSFs. All leasing of properties by SMSFs also needs to be at commercial rates, that is, arm’s-length arrangements.
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.
Just 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.
Commercial or business real property
Commercial property is an exception to the in-house assets and related party acquisition rules, which means it can be a larger percentage of your fund than 5% 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 businesses’ 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) 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.
Kelly owns a four-bedroom house that she lives in, but she also uses one of the rooms as a hair salon. Kelly sells the house to her SMSF and leases it back for her hairdressing business.
Kelly’s private use of the house is more significant than the business use, which means the property is not business real property.
By buying Kelly’s house, her fund has breached the super laws – it could be made non-complying and lose almost half its assets in tax. Kelly could be disqualified from being a trustee and fined.
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 a multitude of property types – such as 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 they are accessed via a fund structure and come with the same kinds of fees and minimum investments as most managed funds. As the Aussiegolfa example reminds us, any managed fund or trust that an SMSF invests in also needs to be ‘widely held’ so it is not to be deemed an in-house asset.
ATO concerns and drawbacks
Spruikers have taken advantage of Australian’s love affair with property for years and SMSFs are as vulnerable to operators trying to leverage their desire to get into the property market (via promoting SMSFs as a means to invest in property) as anyone else.
These operators may be less blatant now, but after completing two reports into the sector last year, the ATO has again raised concerns around property and ‘one-stop shops’.
On releasing Report 575 SMSFs: Improving the quality of advice and member experiences 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 the Australian Securities and Investments Commission (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 probably need to seek independent financial advice.
Borrowing to invest in property
Because of the size of the asset, a lot of property investing in an SMSF is done via a borrowing arrangement specific to an SMSF – 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 trust. The LRBA structure protects the SMSF from being responsible for anything other than the asset in the bare trust.
If your SMSF owns a property asset and decides to sell it, you need to remember that net capital gains are included as part of an SMSF’s assessable income. However, you will be entitled to a capital gains tax (CGT) discount of one-third if the property has been owned for over a year.
First Home Super Saver and Downsizer schemes
Although not strictly relating to investing in property in your SMSF, there are two government schemes relating to property and superannuation.
First Home Super Saver scheme
The First Home Super Saver (FHSS) Scheme allows you to use a certain amount of your superannuation to save to buy your first property.
Via the scheme, which was introduced 1 July 2017, you can make concessional and non-concessional contributions into your superannuation to save for your first home. You can then apply to release those contributions, including earnings, to buy your first home. However, you must never have owned property before to be eligible and you also need to live in the premises you are buying and intend to live in the property for at least six months within the first 12 months after you own it.
You can apply to have a maximum of $15,000 released of your voluntary contributions from any one year, up to a total of $50,000 across all years.
The Downsizer scheme is more relevant to those about to retire and downsize. Individuals aged 65 or over are able to make a contribution to super of up to $300,000 from the proceeds of selling their home. This amount does not count towards the concessional or non-concessional contribution caps and the individual making the contribution does not need to meet the existing maximum age, or work tests for contributing to super.
SMSF and property Q&As
Yes, if the transaction is at market value i.e. on an arm’s-length basis and you may need a documented independent valuation to support the purchase price.
It depends what kind of property it is. Yes, for commercial property, farming property and business premises (if at arm’s length). No for residential property.
Not if your SMSF continues to own it. But it is possible for the property to be transferred to you and for you to live in it then.
Technically yes, but it would be difficult to find a borrower that would lend you the money to do so. It could be done with SMSF funds but that could be a logistical nightmare in terms of organising tenants and understanding overseas laws around landlords and tenants. You would also have to prove the investment case in your investment strategy.
You could buy directly with SMSF funds, but you couldn’t borrow to buy the land and then build the house as the construction of the house would be considered changing the nature and character of the original asset. If you were doing it with SMSF funds you would have to demonstrate how the investment and construction of the property met the sole purpose test and explain how the investment fitted into the fund’s overall investment strategy.
Yes, you could but the property would then be owned by your SMSF and no members (or related parties of members) would be able to live in it.
Yes, you can use SMSF funds but not borrowed funds.
Probably not. If the property were built on a land title belonging to you, any building built on that land would belong to you, and not your SMSF.