Some advantages of buying real estate through a self-managed superannuation fund are tax benefits, greater income and capital growth potential, and the ability to accelerate your retirement savings. No wonder why many Australians consider property investment as a sound investment for their retirement. However, as promising as it is, you must consider all the legal obligations and risks around this investment.
One common question we get from clients planning to hold real estate in their SMSF is, “Can I live in a property owned by my SMSF?” It may sound right to be able to reside in a property owned by your super fund, but the answer to the question is NO. Although there are some exemptions, generally, you can’t live on a property held by your SMSF.
Sole Purpose Test
One main reason you aren’t allowed to live on a property owned by your super fund is the sole purpose test. This test is designed to ensure that the superannuation is being maintained solely for the purpose of providing retirement benefits to the fund’s members or their dependants. All super funds must meet this standard to be eligible for tax concessions available to super funds.
Therefore, if the SMSF trustees decide to purchase a home in order to provide residence for their family, this automatically fails the sole purpose test.
Other situations would breach the sole purpose test; for example, you’re planning to purchase a property from a friend who is in trouble financially. Although there is nothing wrong with the intention, it will still fail the sole purpose test. This is because the motivation behind the investment was to help a friend (a related party) and not because it was to maximise your retirement savings.
How can you ensure that an investment meets the sole purpose test?
On determining whether your fund will pass the sole purpose test, ask yourself this question:
Besides increasing the return for my SMSF, will I (or any of my related parties) obtain a financial benefit from this investment?
If yes, then you’ll have a problem with your fund remaining compliant with the superannuation rules.
Why does the sole purpose test matter?
In the ATO’s words, “contravening the sole purpose test is very serious.” First off, the SMSF will lose its tax benefits, which means the fund will pay more taxes for its contributions and earnings from investments; the trustees will also possibly be dismissed from the roles; and on top of that, the trustees could face civil and criminal penalties.
Can I lease a property my SMSF owns to a relative?
Generally, the rule on residential property purchased through a super fund is that the house cannot be rented by the trustees or anyone related to them, no matter how distant the relationship is.
However, a provision on in-house assets (although very tricky) could allow you to do this. When you lease a home from your fund to a relative, the property becomes an in-house asset. Based on the rules, you’re only permitted to invest up to 5% of the overall market value of the fund’s assets into in-house assets. This means unless you own a huge fund, it’s impossible for you to rent out a property from your SMSF.
Can I live on a property from my SMSF when I retire?
Although you can’t use the assets held in your SMSF due to the sole purpose test, it is possible for you to move into a property that your fund purchased upon your retirement. However, you can only do this provided you have reached the preservation age (between 55 to 60), where you can legally access your super fund and have arranged for the title of the property to be transferred into your name.
Can I lease a commercial property my SMSF owns to a related party?
While renting out a residential home to a relative is impossible, superannuation rules on commercial property are different. Based on the rules of the ATO, business real property (land or buildings solely used in a business) is exempted from the in-house asset and related party acquisition rules.
This means you are allowed to lease a business real property to a member or related parties of the fund without the property being classified as an in-house asset. For example, you can rent out an office building owned by your SMSF to a relative (and even to your business) as long as certain rules are strictly adhered to.
Some important rules when renting out a business real property include: the lease should be at market rate, and the property is primarily used to carry out business activities. You cannot use your super fund to invest in your business. The rent paid for the property should directly go to the SMSF and not your personal funds, as this would violate the sole purpose test.
Having greater control over investment strategies, plus the ability to invest in property using self-managed super fund is an attractive option. However, you also have to keep in mind of the stringent rules that the Tax Office has implemented when it comes to protecting your financial and retirement savings in an SMSF
When making an investment decision, whether buying property or other assets, you have to ensure that this is in line with your investment strategy and should meet the sole purpose test. If in doubt – always ask, “Will this investment/arrangement provide benefits to the members of the SMSF?”