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Directly held property makes up approximately 15% of all SMSF assets, indicating that it is considered an important and significant part of a diversified portfolio.
Investing in direct property is an investment that SMSF trustees are likely to consider at some stage. It may be the motivation to set up an SMSF initially or it may be the opportunity to have business rental income being received by the SMSF from a related business using an asset of the fund, which in turn goes towards adding to the retirement savings of the members of the SMSF.
The clear advantages of owning direct property in your SMSF include receiving the rental income paid to the SMSF for use of the asset and a lower capital gains tax rate on disposal of the property. The rental income adds to your retirement savings and is taxed at the concessional rate of 15%.
- restrictions on the use by you, your relatives and other related parties of residential property owned by your SMSF whether you pay rent for using the property or not,
- lack of diversification due to the large proportion of the SMSF monies which may be needed to acquire a single direct property, and
- dealing with unforeseen events such as early death of a member or divorce requiring the forced sale of the property at an inappropriate time
It is imperative that you are aware of the risks and returns and carefully consider whether property is suitable for your investment portfolio.
Investment strategy first!
Before any investment decision, it is imperative and a legal requirement that as part of your requirements as a trustee, you consider your investment strategy. Your strategy should detail such things as how much exposure you would like to the property market, the form of exposure and how appropriate it is for your current circumstances. A well-diversified portfolio is essential to provide income for retirement and spread investment risk so that any single asset class, such as property, does not dominate your SMSF risk and returns.
A common form of property exposure is direct investment into a property, in the form of either a residential property or commercial property. When purchasing a property within your fund, there are some important considerations you must work through, including:
- Your asset allocation and diversification
- Potential rental income and property expenses
- How close you are to retirement and the need for liquid assets to pay pensions
- Intended use of the property to derive income:
- Prohibition on the use of residential property owned by an SMSF by members or related parties even if market rents are paid for that use
- Limitations on the use of business real property by members or related parties to use wholly and exclusively for business purposes and the need to demonstrate that market rental is paid for that use
Acquiring the property
There is a general prohibition in the superannuation law preventing SMSF trustees from acquiring any assets from related parties such as members or their relatives. Therefore it is not possible under the superannuation rules for your SMSF to acquire residential property from any related party to the fund (like yourself, siblings or parents).
However, the only exception to your SMSF acquiring property from related parties is if the property is within the definition of business real property in the superannuation law.
Business real property generally means land and buildings used wholly and exclusively in a business. Examples include a mechanical repair shop or a retail outlet.
Are you a property investor or property developer?
The more interesting question to be answered in these circumstances is whether the trustees of the SMSF are to be treated as passive property investors or whether they may be considered to be carrying on a property business or even property development? How this question is answered has wide implications for the SMSF and not just from a tax perspective.
There is a strong presumption that trustees acting in that capacity are considered investors first.
Carrying on a business requires more than owning and receiving rent as owner of a rental property. Even where the trustees are more actively involved in the management of the property, the strong presumption is that this is a property investment activity rather than a business.
Whilst there is no specific prohibition preventing an SMSF investing directly or indirectly in property development ventures, extreme care must be taken, specifically with how the developments may be funded and ensuring that your super fund is maintained for the sole purpose of providing retirement benefits.
These arrangements can give rise to significant income tax and superannuation regulatory risks. This includes the potential application of the non-arm’s length income provisions and breaches of regulatory rules about related party transactions.
Seek advice from an SMSF Specialist
An analysis of the investment activities of SMSF trustees and the approach by the ATO as the Regulator show that the ownership of direct property in an SMSF can be viewed in many ways depending on the circumstances of the SMSF.
It is important to seek the advice of an SMSF Specialist in order to assist you in understanding the risks and returns involved with property investment within your fund. To find your nearest SMSF Specialist, use our Find a Specialist function.