Let’s hope this article will help you clear up your misunderstandings with SMSFs and property, as we move through each way a property can be held by the fund.

SMSF acquires property outright

An SMSF can buy a property outright, provided it has all the cash necessary for the purchase and pay for all the expenses. Owning the property outright is the simplest form of ownership, as the fund owns all rights attached to the property.

Key points

• Any property should be registered in name of the SMSF trustee, however, if that is not possible for legal reasons, then a caveat, instrument or declaration of trust should be executed over the property.
• The SMSF’s share of rent is to be paid to its bank account.
• The SMSF’s share of property expenses should be paid or accounted for in the fund. In some cases, expenses may be paid by a member or other party and must be reimbursed to the payer to ensure they are not recorded as a contribution or possibly a loan to the fund. However, if the expenses end up being treated as contributions, ensure the relevant contribution cap is not exceeded, otherwise excess contributions tax could apply.
• The property cannot be used as security, which includes mortgages, liens, caveats and other encumbrances.
• The property can be rented to a related party – provided it’s used wholly as business premises that are leased on market terms.

Let’s look at a case study

Barbara’s SMSF is considering buying an apartment listed at $515,000. With an additional $15,000 in conveyancing fees and stamp duty, the total cost is $530,000.  The SMSF has $175,000 in available cash, leaving a shortfall of $355,000. Barbara can make non-concessional contributions during the relevant financial year and can access the ‘bring forward’ rule because she is under 65. It’s fortunate Barbara has a total superannuation balance of about $1.3 million, which allows her to maximise her non-concessional contributions over two financial years. This can be done by Barbara making a non-concessional contribution of $100,000 in the first year and using the three-year bring forward rule in the next financial year to make a non-concessional contribution of up to $300,000.  This will help to solve the shortfall Barbara’s SMSF has to buy the property.

Barbara could use tax concessions for superannuation contributions effectively by combining concessional contributions with the non-concessional contributions she intends to make to the SMSF. The cap for the 2018/19 and 2019/20 financial years is $25,000, which, after tax of 15% has been paid by Barbara’s SMSF, would net $21,250 each financial year. By doing a bit of juggling, she could come to the right combination of tax deductible and non-deductible contributions.

Another way of solving the shortfall to purchase the property could be to introduce another member such as Barbara’s spouse.  He or she may have a healthy super balance to transfer or be eligible to make concessional and non-concessional contributions to Barbara’s SMSF.

SMSF and related party acquires property as ‘tenants in common’

An alternative solution to buying the property outright could be for Barbara’s SMSF to own part of it as ‘tenants in common’, maybe with a fund member such as Barbara. This allows the SMSF to have an interest in the property, say, a residential property owned with Barbara who is a ‘related party’.  Providing it is not leased to her or another related party, then it may work. Don’t forget that property owned directly by the super fund, although owned as ‘tenants in common’, is unable to be mortgaged.

The ownership of property as tenants in common is considered a tax law partnership for ABN purposes. But if the property is a commercial property, it will be necessary to register the SMSF for GST. A Statement of Income and Expenditure should be prepared for the partnership to work out the net income to be distributed to each part owner. There is no need for a partnership TFN, as each partner simply discloses their share of net income from the property in their respective tax return.

One practical issue with the collection of rents and payment of expenses is that each party needs to receive the correct amount of net rent. This may be difficult to achieve in the long run and may end up with the SMSF breaching the rule to keep fund assets separate from those of the related party. It can be solved by the fund and the other owner(s) having a joint bank account to receive income and pay expenses.

If the property is purchased as tenants in common, it is important the correct names are on the purchase contract. Both the names of the SMSF trustee(s) as trustee for the superannuation fund and the joint purchaser would usually be recorded on the contract. For land purchased in Victoria, it is possible for the contract to include an ‘and/or nominee’ clause, which enables the contract to be in another’s name but at the time of settlement will nominate the superannuation fund or other joint owner of the property.

Use of a ‘non-geared’ unit trust or company

As another option a ‘non-geared’ unit trust or company may provide a solution where an SMSF and a related party hold units in a private unit trust or shares in a private company. The trick here is client discipline and understanding the issues involved. If the unit trust or company fails to meet the strict requirements of the rules, any breach will mean compliance problems for the fund.

It is possible for the ‘non-geared’ company or trust to easily fall foul of the rules in SIS regulation 13.22D if they do one of the following:

• Lease the property to a related party, unless the property meets the definition of ‘business real property;
• Invest in another entity, including owning shares in another company or units in a unit trust;
• Allow a charge over the property it owns, such as a mortgage;
• Borrow money;
• Carry on a business in the unit trust.

Ungeared trusts or companies holding property in this way allow the SMSF and the other unit holders to finance the acquisition of the property without the other unit holders making contributions via the fund to finance the purchase. This structure has the advantage, over the tenants in common structure, as the SMSF can increase its (indirect) interest in the property. In contrast, a ‘tenants in common’ structure does not allow the SMSF to acquire any additional portion of the interest in residential property where the ‘joint tenant’ is a related party. This is because of the operation of rules which prohibit the fund acquiring certain investments from related parties (section 66 of the SIS Act). This does not apply in the case of business real property.

The use of a non-geared unit trust or company allows the SMSF to acquire the units held by the related party or parties over time to increase its ownership of the trust or company to of 100%. The units must be transferred at market value, so this may require future external valuations, and there may be income tax and stamp duty considerations.

The practical issues of collecting rents and paying expenses is easily solved by using the trust or company which allows it to have a bank account to which rents are added and expenses paid. At the end of the financial year, the net income is determined and paid to the unit holders.

Any trust or company to be used for this purpose would need to be in place prior to executing a purchase contract in the name of the trustee of the unit trust. There’s also establishment costs of the unit trust and company as well as the annual financial statements, tax return and the annual ASIC fee for any company.

SMSF acquires the property via a Limited Recourse Borrowing Arrangement (LRBA)

Shortfalls in financing property investments can be funded by using an LRBA. Where an LRBA is used to acquire property, it must be in place prior to entering into the contract for purchase and that the correct name is placed in the contract. The name on the contract will depend upon the state that the property is situated. Usually, it is the trustee of the security trust, but it is worthwhile to seek legal advice on the correct entity to be named.

The main issues with LRBAs is getting the parties to understand how they work as there are a lot of components to the beast. It is those LRBAs where the loan to the SMSF is made by a non-arm’s length party which create the most distress as perception of some client’s over-rides the technical requirements they need to pay attention to.

Any related party loan must comply with the ATO’s rules for an SMSF related party limited recourse loan as part of an LRBA. In general, the terms of a related party loan will comply with the ATO’s rules if:

• The interest rate on the loan complies with the Reserve Bank of Australia Indicator Lending Rates for banks providing standard variable housing loans for investors.
• The interest rate may be fixed or variable, but any fixed rate can be only for a maximum of 5 years
• The maximum term for the loan is limited to no more than 15 years. Fixed term loans must be renewed every five years
• The loan to market (LVR) ratio is limited to no more than 70% when the loan is entered into
• There is a registered mortgage over the property
• Repayments of the loan must be a principal and interest loan payable monthly, and
• Any loan agreement is required to be executed and in writing

Getting the documentation right needs the oversight of an eagle eye due to the many parties that can be involved in the arrangement and the ease at which the relevant party on some documents can be incorrect. Getting mistakes corrected after the LRBA has been completed can be another costly exercise for some.

Other matters

And then there’s the investment strategy to ensure the fund can invest in property in the manner desired. The strategy should be reviewed, and any update made to take into consideration the significance of a large and possibly illiquid asset within the fund.

The purchase of property by an SMSF can have many paths depending on how it will be purchased and the parties to it. Making sure the ‘I’s are dotted and the ‘T’s crossed is essential to ensure it forms part of a long-term strategy for the fund and not a toxic cocktail that can only be unmixed at a price. The main lesson with SMSFs investing in property is that there are many ways to do it and the most suitable way depends on the circumstances.  That’s why getting advice on the how, when and why of the investment is always wise.

Important: 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 regard to your circumstances.