What is the 5% SMSF Rule?
A lot of articles have been written about the 5% SMSF rule. What is it?
The 5% rule relates to the limit of in-house assets (INHA) a SMSF is able to own or acquire.
INHA include a loan to, a lease to or an investment in, a related party of a superannuation fund.
Who is a ‘related party”? This can be complex but simply it includes a member of a SMSF, a relative of a member and associates of a member.
Exceptions to the INHA rules include:
- a SMSF can lease business property to a related party or acquire business property from a related party
- a SMSF can acquire listed shares and other listed equities, ungeared unit trust or company, managed funds or property trusts which are not listed and are widely held unit trusts (generally has more than 20 unrelated unitholders)
How is the 5% In-House Asset threshold measured?
The 5% limit is based on the total assets held by a SMSF at a particular time. It is not based on the net assets. The assets must be valued at market value. The assets of a fund include:
- investments including shares, units, property, managed funds
- cash including term deposits
- tax deferred assets
- debtors
Example – A SMSF has net assets of $450,000 as at 30 June 2024. The fund’s total assets are valued at $1,000,000. The fund’s liabilities are $550,000 made up of a limited recourse borrowing arrangement (LRBA) in place with borrowing of $525,000 and other liabilities of $25,000.
The assets include a loan of $45,000 to a private company which is controlled by the members of the SMSF (related party loan) making it an in-house asset.
The percentage of INHA at 30 June 2024 is $45,000/$1,000,000 = 4.5 % which is under the 5% threshold limit and thus the SMSF can continue to hold the loan made to the related company.
The fall and rise of asset markets, especially the property market, impacts the 5% threshold.
Hint – Review the market value of your SMSFs assets near the 30th June. It may be possible to bring forward contributions or defer a rollover or member benefit payment until the 1st of July boosting the fund’s assets to ensure the 5 % threshold is not exceeded.
When is the 5% limit measured?
- When it is first acquired – in relation to the example above the loan of $48,000 was established on the 10th January 2024 which reduced to $45,000 by the 30th The 5% limit is measured at the date the loan was established. The SMSF trustee needs to ascertain what the market value of the fund’s total assets are at 10 January to calculate the percentage of INHA it is able to acquire.If the fund has no other existing INHA at 10th January and the total market value of the assets were say $960,000 the percentage of INHA would be $48,000/$960,000 = 5 %. The fund can make a loan to the related company as it does not exceed the 5% threshold.
- As at 30th June – assume the same example but the property market fell significantly, and the fund rolled over $70,000 to another complying fund as requested by one of the members reducing the value of the total assets of the SMSF at 30th June 2024 to $850,000. The percentage of INHA at 30th June 2024 was $45,000/$850,000 = 5.29% which exceeded the 5% threshold. The fund must prepare a formal written plan and reduce the INHA back to the 5% threshold before the 30th June 2025.Hint – the excess amounts to only $1,309, yet the entire loan may have to be repaid, rather than just the surplus portion. The SMSF possesses a single INHA, which is the $45,000 loan. To address the breach, the fund must sell the only INHA to comply with SISA regulations. Even if there is a market rebound by June 30, 2025, and the INHA percentage returns to within the 5% limit, the entire loan might still need to be paid off.However, it may be worthwhile to request a discretion from the ATO to treat the excess as not breaching the INHA rules as the excess amount is immaterial and provided the INHA are below the 5% threshold at 30th June 2025 the ATO may grant a discretion under these circumstances.
Other SISA regulations, such as the sole purpose test and the requirement to keep assets separate from personal assets, along with tax laws like the non-arm’s length income (NALI) rules, may also influence the holding or acquisition of an INHA. For instance, lending money to a SMSF member below the 5% threshold is not restricted under the INHA guidelines; however, section 65 of SISA forbids lending money or providing financial assistance to a member or their relative without any exceptions. This section only applies to members and their relatives and does not prohibit lending to a related company or unit trust.
Seek advice from your SMSF Specialist or Licensed Financial Adviser before acquiring or holding INHA at 30th June to ensure compliance with the super laws and regulations (SISA) and taxation laws.