Can my SMSF buy my property?
Possibly. The answer hinges on what type of property is my SMSF buying and who will the tenant be? As a general rule an SMSF cannot buy a purely residential property from a member or one of their associates, known as related parties.
Related Parties
I am a member and trustee of my SMSF and therefore I am a ‘related party’ of the fund. I must tread carefully to avoid coming to grief with the ATO who regulates SMSFs.
Why is being a ‘related party’ a problem?
Firstly, a related party includes myself as a member and trustee of the fund and can also include my family members. A related party can also include myself and my family members and any company or other entity we control together. Fred, who is just a friend and not part of my family, can be a related party as we share rental income from an investment property, and we are deemed to be in a partnership. Any partnership I am in is automatically caught in the web of related party relationships.
Generally, you can’t buy a property from a related party unless it counts as business real property.
Business Real Property
Like all rules there is an exception.
A property which is ‘business real property’ is exempt and provided I pay the going market rate and I transfer the property to my SMSF legally my fund can buy it.
Business real property can be a warehouse, an office block, industrial premises, a café or other commercial building. Surprisingly, it is not limited to commercial buildings or a building zoned as commercial. It can include a residential building which is used wholly to run a business such as a hairdresser, accountant, massage business or real estate agent. Provided the building or land is used wholly in a business it can be classified as business real property and potentially can be transferred to a SMSF.
Examples of property which I might own which cannot be purchased by my SMSF include a holiday apartment, residential investment property or vacant land (not used in a business).
Some grey areas include farms, vacant land and businesses renting residential premises.
Owning a farm includes the farmhouse where I live. There are special rules that allow farmers to transfer their farms to their SMSFs. The farmhouse where I still live cannot exceed 2 hectares (about 5 acres). The farm must be used as part of a primary production business. Most vacant land will not pass the test but if I am a developer and the land was part of my stock it could be classified as business real property. Similar to land, residential premises will not pass the test either but if the renting of residential premises has the hallmarks of a business it may be treated differently.
Who is the Tenant?
I or my related parties such as the family business can lease business real property from my SMSF. There are some crucial rules around a related party lease.
- the SMSF must have a formal lease between the fund and the tenant
- rent and other terms and conditions of the lease must be at arm’s length
- supporting external evidence of the market value of the rent must be obtained i.e. a formal rent valuation from a qualified valuer is best evidence but other evidence can be obtained from real estate agents who also provides rent of similar properties
My SMSF must enforce the lease. The trustee cannot accept me saying I will make up the rent before the 30th June or decide not to pay the rent for a couple of months as I have a cashflow problem. If the terms say monthly, generally most commercial leases are monthly, I must pay rent on time.
What are other issues to be considered?
The big issue is non-arm’s length income (NALI). If my family business is the tenant and the business wants to pay rent which exceeds the normal market value it could mean my fund is penalised. Tax of 45% may be applied to the net rental income and the capital gain on sale of the property.
Another arm’s length issue relates to paying under the market value for a property or property expenses not being paid or reimbursed by the fund resulting in a similar penalty.
My SMSF buying my property must be allowed for in the fund’s governing rules and must be included in the investment strategy. Particularly if the property is the major asset of the fund as the trustee must be able to explain why the purchase benefits the member’s retirement and meets the cashflow and liquidity requirements of the fund.
To learn more about Property within an SMSF checkout our detailed SMSF Property Investment page.