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. 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.
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.
As the latest Australian Taxation Office (ATO) figures reveal, a significant number of SMSFs do indeed invest in direct property. In the March quarter 2021, approximately 10.5% of all SMSF assets were invested in non-residential real property and another 5.6% 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.
A case study A recent case – between the ATO and an SMSF – 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 that 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
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,” says SuperConcepts executive manager, SMSF technical and private wealth, Graeme Colley. “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.” 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 interrelated parties, which was the case in Aussiegolfa.
Direct property
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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 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.
For more on independent advice, see SuperGuide Independent financial advice: Why it’s important and how to find it.
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.
Learn more about borrowing to invest.
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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.
Learn more about CGT and how it relates to SMSFs.
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 (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 $30,000 across all years.
Need to know: In the May 2021 Federal Budget, the government announced it would increase the maximum amount you can apply to withdraw from the FHSS Scheme to $50,000. Voluntary super contributions made from 1 July 2017 can count towards your total amount released. This change is proposed to start from 1 July 2022 but is not yet law.
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.
Need to know: In the May 2021 Federal Budget, the government announced from 1 July 2022 the age at which you become eligible to make a downsizer contribution will reduce from age 65 to age 60. This change is not yet law and must still pass Parliament.
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