Managing a self-managed super fund is tricky at the best of times, but it becomes even more complicated once you decide to use your SMSF for property investment.
And it becomes more complicated still once you take the additional step of buying a commercial property that you then rent back to your business.
Get the process right, and it could really improve your financial position. But get it wrong, and the Australian Taxation Office might start taking an unhealthy interest in your dealings.
Generally, SMSFs aren’t allowed to borrow money or to conduct business deals with fund members. Buying ‘business real property’ (as it’s called) is an exception to these rules, but one that’s monitored closely by the tax office.
So we’re now going to give you an overview of the correct way to buy an SMSF property to rent to your business.
4 steps to follow when renting a property from your SMSF
First, you need to make sure the SMSF’s decision to buy an investment property corresponds with its investment strategy. All your fund’s investments need to be “in accordance with your investment strategy so that you are on track to meet your retirement goals”, according to the ATO.
Second, the transaction needs to be made on a commercial ‘arm’s length’ basis. So if the SMSF buys a property you already own, the purchase price needs to reflect market rates. Also, the rent the SMSF charges your business needs to reflect market rates.
Third, if you take out a loan to fund the SMSF property purchase, it needs to be through a limited-recourse borrowing arrangement.
Fourth, the property must be ‘business real property’ – i.e. property used for business purposes.
What does and doesn’t qualify as business real property
Minor exceptions may be allowed to the rule about using the property for business purposes, according to two ATO case studies.
In the first case study, Kevin owns a large dairy farm that also includes a house. Kevin sells this property to his SMSF, and the SMSF then rents the property to Kevin. In this scenario, the farm qualifies as business real property, because the main use of the land is for agriculture, and the use of the house is incidental and relevant to the business.
However, the second case study is a different matter. Kelly owns a four-bedroom house, and uses one room to run a hair salon. But Kelly is not allowed to sell the house to her SMSF and rent it back, because the main use of the house is for residential rather than commercial purposes. So the house does not qualify as business real property.
Why the ATO has strict rules around SMSF property transactions
As a general rule, the ATO doesn’t like SMSFs to borrow money, because the fear is that if people take too much risk, they will blow their savings and the government will have to fund their retirement.
The ATO also frowns upon individuals or businesses that use sneaky arrangements to avoid paying their fair share of tax.
That’s why there are strict rules around business owners purchasing a property through their SMSF and then renting it back.
Take note of the ATO’s warning: “If you don’t comply with the investment restrictions we may impose significant penalties, including disqualifying you as a trustee and even prosecution. It’s a good idea to speak to an SMSF professional to make sure your investments comply with the law.”
Rhiannon Leonard is a property lawyer at SMSF Conveyancer.
Want to make sure your SMSF property transaction is handled correctly? SMSF Conveyancer can help. Contact us on 03 9070 9810 or fill in this online form to discuss your options.