Many people assume you can’t develop property in a self-managed super fund (SMSF). After all, superannuation laws clearly state that property purchased through a SMSF must meet the ‘sole purpose test’ of solely providing retirement benefits to fund members – and property development is a business, right?
While both of these points are true, this doesn’t necessarily mean you can’t develop within the SMSF environment – as confirmed by the Australian Tax Office (ATO).
The ATO’s view on SMSF property development
Following an increase in property developments involving SMSFs, the ATO published an SMSF Regulator Bulletin confirming:
- Property development can be a legitimate investment for SMSFs as long as the fund complies with the sole purpose test
- There are no specific prohibitions preventing an SMSF investing directly or indirectly in property development
That said, staying on the right side of all the rules and regulations can be extremely tricky – so you’ll have to watch out for more potential pitfalls than usual. Which, given the general complexity of SMSF legislation, is saying something.
So how can you develop property in a SMSF?
1. Review your trust deed and investment strategy
Your trust deed must specifically allow for a business to be carried out – which most don’t, so you’ll likely have to update it. As the deed is a legal document, it’s a good idea to have an experienced SMSF conveyancer do this for you. At the same time, review your investment strategy and risk profile and update as necessary.
2. Own the property outright (ideally)
Limited-recourse borrowing arrangements (LRBA) allow SMSFs to finance assets such as property. One problem though: money borrowed through a LRBA can’t be used to improve an asset.
The easiest way to compile with this rule is to own the property outright. But what if your fund doesn’t have the cash? You may be able to get around the LRBA restrictions using a unit trust. However, get expert legal and tax advice before going down this route as it can be very technical and penalties for breaking the rules can be severe.
3. Keep everything at arms-length
As the ATO notes in their regulator bulletin, many SMSFs investing in property often deal with related parties as part of that development.
However, the Superannuation Industry (Supervision) Act 1993 (SIS Act) prohibits:
- trustees of a SMSF from providing financial assistance to members or relatives of members
- SMSFs from buying assets from a related party, except for ASX-listed shares, widely held trusts or commercial property
So if you do want to employ a related party such as a builder to work on your development, you need to ensure they are paid market rates to comply with the SIS Act.
But your potential compliance issues don’t stop there.
Take ‘cost-plus’ contracts, for example.
A cost-plus contract is a contract where a contractor obtains material and services throughout the stages of the building process. You then repay all their expenses plus an agreed margin to cover the contractor’s overheads and profits.
The thing is, you’re now buying what could be considered in-house assets (building material) from a related party – which breaches the SIS Act.
In this scenario, you could avoid breaching the SIS Act by:
- Buying the materials yourself from an unrelated party – which could mean the loss of trade discounts
- Writing a building contract appointing the related contractor as your agent – though you’ll need to reimburse the contractor as soon as the materials are purchased
- Opening a bare trust in the contractor’s name – for them to use exclusively to purchase building materials
Be very careful
As you can see, developing property in a SMSF might be legal, but it’s also very complex and full of compliance traps. And while the ATO may allow for property development, that doesn’t mean they don’t have any concerns.
As such, expect greater scrutiny from the tax office if property development is what you want to do with your SMSF.
Rhiannon Leonard is an SMSF conveyancing lawyer at SMSF Conveyancer.