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. A significant number of SMSFs do invest in direct property and statistics from Class Limited showed this to be as high as 27.1% in 2016. This includes both residential and non-residential (i.e. commercial property).
Of the SMSFs that do invest in property approximately half of the fund is invested in that property – 47% for residential and 51% for non-residential.
However, the reality of investing in property is that it is quite complicated and should never be considered as an easy way to enter the property market.
Just like any other asset an SMSF invests in, and perhaps even more so if the property asset is to represent a large allocation 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 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
An SMSF can only acquire a property used wholly for business or farming purposes from a related party at market rates and under very specific conditions.
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 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 i.e. “arms-length” arrangements.
A case study
A ground-breaking court case last year – between the Australian Taxation Office and an SMSF party – emphasises the importance of motive when it comes to understanding the sole-purpose test. It is an illustrative example of both the application of the sole-purpose test and the in-house asset definition.
In the Aussiegolfa Pty Ltd (Trustee) v. Federal Commissioner of Taxation case Aussiegolfa Pty Ltd was the trustee of the Benson Family Superannuation Fund (Benson Fund), an SMSF which invested in a managed investment scheme, the DomaCom Fund. Benson Fund acquired units in a sub-fund of the DomaCom Fund, -the ‘Burwood Sub-fund’. That fund acquired a property in Burwood, Victoria. The ownership of that fund was represented as follows:
- 25% by Aussiegolfa Pty Ltd as trustee of the Benson Family Superannuation Fund;
- 50% by the mother of a member of the fund; and
- 25% by the sister of the member of the fund and her husband.
The DomaCom Fund entered into an arrangement with Student Housing Australia Pty Ltd (Student Housing Australia) to lease the Burwood property. The initial tenants were third parties who were not related parties, however Student Housing Australia then decided to lease the property to a daughter of a member of the fund from February 2018.
The rental arrangement was on the same monthly rental that was paid by the previous two tenants i.e. still at market rates. The value of the units in the DomaCom Fund constituted 7.83% of the total assets of the Benson Fund at market value. Therefore, it was in breach of the in-house asset rule as more than the 5% of the fund was invested in a unit trust that leased the property to a related party. However, if the investment in the trust was considered to be in a widely held unit trust, it would be excluded from the definition of ‘in-house asset’ in terms of the SIS Act.
Following a determination by the ATO, the matter was referred to the Administrative Appeals Tribunal. Its decision – that the units held by Aussiegolfa Pty Ltd in the Burwood Sub-fund did constitute an in-house asset of the Benson Fund and the lease of the Burwood property to the daughter of the member was in breach of the sole purpose test – was appealed by Aussiegolfa.
A final decision in the Full Federal Court was that the leasing of the property was not in breach of the sole purpose test and that the units held in the Burwood Sub-fund were in-house assets of the Benson Fund.
The ATO has issued a Decision Impact Statement here.
This decision impact statement suggests that the ATO views the decision as not necessarily a precedent and that each case like this will be considered on their merits.
However, for the sole purpose test it does highlight the importance of motive when benefits, other than superannuation benefits, are determined to be incidental or not.
“In the case the decision seems to be influenced by the fact that the student accommodation was leased firstly to arm’s length tenants at market rents and subsequently leased at market rents to a related party,” SuperConcepts executive manager, SMSF technical and private wealth, Graeme Colley, says.
“The decision was that the original motive of the trustees was not altered by the change in tenants from arm’s length to related party. However, had the rent paid by the related party been on a different basis then it would indicate the motive may have changed and resulted in a breach of the sole purpose test.”
However, the case is also instructive when it comes to understanding the difference between an in-house asset and a widely-held unit trust asset. A trust, for this purpose, needs to be held more widely than by three inter-related parties, which was the case in Aussiegolfa.
As stated earlier, while residential property makes up the largest proportion of property investments, a significant amount of SMSFs invest in commercial property or business real property, with a small percentage investing in both.
Residential property represents standalone houses, apartments, semi-attached houses etc with rent representing 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 2 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 trust (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, 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’ for it 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 Australian Taxation Office 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 better 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.
For more on this see our article on borrowing to invest here.
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. For more on CGT and how it relates to SMSFs see our article here.
First home saver scheme and downsizer scheme
Although not strictly relating to investing in property in your SMSF, there are two government schemes relating to property and superannuation.
The First Home Super Saver Scheme (FHSS) 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 $30,000 across all years.
The downsizer scheme is more relevant to those about to retire and downsize.
Since 1 July 2018, 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
Can I sell property from my SMSF to myself?
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.
Can I sell my investment property to my SMSF?
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.
Can I live in my SMSF property when I retire?
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.
Can SMSFs invest in properties overseas?
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.
Can I buy a block of land and then build a house on it with an SMSF?
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.
Can we add our daughter to our SMSF and purchase a property together?
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.
Can you buy furniture in your SMSF to outfit the unit that is also in the SMSF?
Yes, you can use SMSF funds but not borrowed funds.
Can we use our super cash to build a granny flat on our own property as a means of getting a rental return, which our SMSF will get all of the rental income?
Probably not, as 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.