SMSF property ownership: Trustee requirements and obligations

Investment strategies are not a set-and-forget document. In fact, the superannuation rules require a fund’s investment strategy be reviewed regularly with regulatory guidance suggesting that trustees carry out this review annually, at a bare minimum, but also at other times where the fund’s position may change.

Changes to the fund’s position that would usually warrant a review could include adding or removing fund members, the commencement of a pension or the payment of a large lump sum benefit, or where there has been a significant market event that could affect the value of the fund’s assets.

Where an SMSF owns direct property, there are a number of specific issues within the fund’s investment strategy that should be addressed both prior to the property being acquired and then each year as part of the review process.

Diversification

Due to the large investment amounts required, direct property ownership through an SMSF will often result in a lack of diversification. The super rules would therefore require SMSF trustees take this into consideration when developing and implementing their fund’s investment strategy.

Although there is no formal requirement for an SMSF to hold a diversified portfolio of assets, there is a requirement that trustees at least consider the need to diversify and to consider the associated risks where there is a lack of diversification.

Having in place clearly documented reasonings for the purchase of the property, including market rates of rental income and expected capital growth, will go a long way in meeting the investment strategy requirements, especially where diversification is an issue.

SMSF trustees need to make sure that this is also addressed when carrying out their annual investment strategy review for their SMSF.

Liquidity and cashflow

Consideration should be given to the cashflow and liquidity requirements of the SMSF, including pension payments, any relevant loan repayments, property repairs and maintenance, tax expenses and other general fund expenses.

Due to the illiquid nature of direct property, trustees need to ensure that all of these expenses can be met with existing and future cashflow from the SMSF.

Where the cash flow requirements of an SMSF change, for instance where a pension is commenced by a member, trustees need to assess the continued appropriateness of owning direct property and if the cashflow from the property will be sufficient to meet these ongoing payments.

It is also important that SMSF trustees maintain clear evidence around these assessments, which would usually form part of their investment strategy review.

Trustee covenants

Trustee covenants refer to certain rules and obligations that are deemed to apply to all SMSFs and included in the fund’s trust deed by default; essentially imposing a best-interest duty on the fund’s trustees.

Some of these covenants include:

• The need to perform the trustee‘s duties and exercise the trustee‘s powers in the best financial interests of the beneficiaries.
• The need to keep the money and other assets of the SMSF separate from any money and assets that are owned by the trustee personally.
• A requirement to exercise the same degree of care, skill and diligence a prudent superannuation trustee would exercise on behalf of the beneficiaries.

SMSF trustees would need to consider holding relevant insurance policies that protect the SMSF’s property assets to meet these covenants.

Keep in mind that any insurance policy that is taken out must be held in the name of the SMSF trustee and any associated expense relating to these insurances, such as insurance premiums or a claim excess, must be paid from the SMSF’s owns resources. Failing this can lead to multiple compliance issues.

Correct ownership

As mentioned, the SIS covenants require that all SMSF assets be held separately from assets that the fund trustees own personally. This is best achieved by holding all SMSF assets in the name of the SMSF trustees with representation to the fund.

For instance, a direct property owned by an SMSF with a corporate trustee would usually be held as: Smith Pty Ltd as trustee for the Smith Superannuation Fund.

Where the SMSF has individual trustees, direct property would usually be held as: Roberta Smith and Adam Smith as trustees for the Smith Superannuation Fund. 

Paperwork

All relevant paperwork for the property needs to be kept by the SMSF trustees and, in most cases, these records need to be maintained for at least five years.

However, when it comes to property ownership, we need to consider that there may be certain events that occur many years after the initial acquisition, mostly relating to taxation events including capital gains tax. It would therefore be prudent to maintain all records relating to the property for at least five years after the final sale of the asset.  

It is also important that there be documentation in place around any lease arrangement relating to the property. These arrangements should be set out in a written, legal lease document where the terms are consistent with an arm’s-length arrangement. SMSF trustees should also make sure that all the terms of the relevant lease are enforced.

Valuation requirements

There are certain valuation requirements that SMSF trustees need to address. These include:

• To value all fund assets at market value when preparing the SMSF financial accounts and statements.
• To determine the market value of a member’s account balance when that member commences a pension.

The funds auditor will check this when they carry out their annual audit of the fund, so it is important that the valuation is not only carried out in the appropriate way, but that clear and concise evidence is maintained on file to show what was actually carried out.

Importantly, trustees need to provide both objective and supportable evidence to support the valuation process that was used. As the value of a real property held by an SMSF would in most cases represent a significant proportion of the fund’s value, it would usually be appropriate to use the services of a qualified valuer for this process.

The ATO website sets out the following as a guide to the relevant factors and considerations for valuing real property: 

• The value of similar properties and recent comparable sales results
• The amount that was paid for the property in an arm’s-length market – if the purchase was recent and no events have materially affected its value since the purchase
• An independent appraisal from a real estate agent (kerbside)
• Whether the property has undergone improvements since it was last valued
• A rates notice (if consistent with other valuation evidence)
• For commercial properties, net income yields (not sufficient evidence on their own and only appropriate where tenants are unrelated).
• Unless the property has been recently purchased by the fund, you should consider a variety of sources to substantiate the market value of real property. Generally, it is not sufficient for valuations to be based on only one item of evidence in the above list.

The information contained in this article is general in nature.