SMSFs have a very powerful story for anyone wanting to invest in commercial, retail and industrial property.
You get tax concessions when you make super contributions; tax concessions on investment earnings; your fund can invest in business premises if that’s what you want to do; capital gains are only taxed at 10% and, if you structure the sale transaction right, you might pay no CGT when you sell the asset, when paying a pension from your fund.
These facts make SMSFs very attractive for anyone running their own business, especially when they want the super fund to own the premises where they, or their relatives, run their business.
The ‘in-house assets’ test restricts how the trustees, members, their relatives and other entities they control (such as trusts, companies or partnerships) can use the money in a super fund for their own purposes. In general terms, only 5% of the market value of a super fund’s assets can be used by these people.
However, this 5% restriction doesn’t apply to an SMSF that owns “business real property” that is leased to anyone – including the trustees, members, their relatives and so on.
What is business real property (BRP)?
BRP is a freehold or leasehold interest in real property, that is, land and buildings, and any interest in Crown land (other than leasehold interest), which is capable of assignment or transfer. The property needs to be used wholly or exclusively in one or more businesses.
BRP often doesn’t include property used partly for running a business and partly for residential purposes.
For example, suppose an SMSF owns a retail shop and above the shop is a small flat, which is zoned residential and is therefore rented out accordingly. It’s unlikely that an SMSF would be deemed to be running a residential property rental business so this particular property probably won’t satisfy the requirement to be used wholly and exclusively by one or more businesses.
As a result, such a property can’t be leased to the SMSF’s members, their relatives or companies, trusts or partnerships that any of these people control.
The above restriction doesn’t apply to farmers. An SMSF can own a farm and lease it to the member, i.e., the farmer, as long as no more than two hectares of the land contains a dwelling that is used for private or domestic purposes. The predominant purpose of the entire rural property can’t be for private or domestic purposes.
Subject to all these restrictions, small businesses can use their SMSF monies to own their business premises.
This is a handy way for a business to gain access to cash or expand into larger premises. For example, suppose a business owns their current offices, which are worth $250,000. The business owners also have an SMSF, which has $400,000 in it. The business needs bigger premises but it doesn’t have the cash to buy the new place outright, or expand the existing premises, and doesn’t really have the cash flow to support any new borrowings for either of these options.
There are a couple of alternatives available. The business owners could sell their current premises to someone else and have the super fund acquire newer larger premises. In this way, the business would generate some additional funds.
Alternatively, the business owners could sell their business premises to the SMSF and use the remaining funds in the SMSF to expand the premises.
Any lease arrangement between a trustee and a related business must be done at arm’s length. The SMSF trustee must make sure the arrangement is documented in the same way that commercial property leases are done in the local area. This would need to include the provisions for a market rent, for regular rental reviews, for late or no payment penalties and so on.
The trustee must be prepared to enforce its rights (including imposing penalties) in exactly the same way they would if an unrelated business was leasing the property. The conflict of interest for an SMSF trustee in these circumstances is pretty obvious and it’s common for trustees to miss rental reviews and allow their related businesses too much slack when it comes to paying rent on time.
Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.