Your accountant has set up your self-managed superannuation fund (“SMSF”) and you are now keen to start using the SMSF for investment purposes. You have heard that property is a great investment for a SMSF and you are about to sign a contract…
STOP! Before you purchase a property through your SMSF, there are a number of rules that must be complied with. If your acquisition is non-compliant, the ATO has wide-reaching powers which can include civil and criminal penalties or the freezing of assets of the SMSF.
The key rules are:
- The purchase of the property by the SMSF must be consistent with the ‘sole purpose test’. This means that the SMSF must be maintained for the sole purpose of providing benefits upon death or retirement of the members. An effect of this is that the SMSF cannot purchase a property so that a member or related party of the member can live in the property – even if they will be paying rent. Members or their related parties also cannot later move in to or rent the property, even if it was previously rented to another party.
2. The property cannot be purchased from a ‘related party’ of the SMSF. A related party of the SMSF is a member of the SMSF, a employer-sponsor of the SMSF or an ‘associate’ of either of those entities. An associate is defined very broadly and can extend to the following:
(a) Relatives of members;
(b) The directors of the trustee company of the SMSF;
(c) Partners of a member in a business partnership and the spouses and children of that partner; and
(d) Companies in which the member controls the company (i.e. by holding a majority voting interest).
There is an exception to this rule if the SMSF is acquiring ‘business real property’ from a related party of the SMSF at market value. Business real property is an interest in real property whereby the real property is used wholly and exclusively in one or more businesses, whether carried on the SMSF or not. Your accountant will be able to tell you whether the property is business real property or not.
3. The SMSF cannot borrow money to fund the purchase, except through a limited recourse borrowing arrangement. Limited recourse borrowing arrangements are very strict loans whereby:
(a) the money borrowed will only be used to acquire the property or for permissible expenses such as conveyancing fees or stamp duty. It is permitted to use the borrowed funds to maintain or repair the property but you can’t improve the property using those funds;
(b) the property will be held on trust by what is commonly known as a custodian trustee for the benefit of the SMSF. Once the loan is repaid, the custodian trustee will transfer ownership to the SMSF;
(c) any rights of the lender against the trustee as a result of a default are limited to the property that has been acquired. Under normal lending arrangements, all assets of a person or entity (subject to the priority of other interests and compliance with statutory requirements) are generally able to be taken by a lender to satisfy the debts of a borrower. Lenders are permitted to request personal guarantees from other persons to secure the loan; and
(d) there is no other mortgage or charge against the property.
So what are our tips for ensuring a smooth purchase of property by your SMSF?
- Visit your accountant or financial planner before purchasing the property to ensure that your proposed investment is appropriate for your SMSF and will be compliant with the rules.
- Don’t purchase property owned by a related party of the SMSF unless it is “business real property”.
- If you are relying on the “business real property” exemption, ensure that your accountant confirms that the property meets the requirements of this exemption.
- Visit your lawyer with the contract before you sign it so that they can review it and ensure that it is appropriate.
- If borrowing money for the purchase, also visit your bank before signing the contract to confirm any specific requirements they have for the contract and whether they may require personal guarantees. For example your bank may require the buyer entity to be described in a particular way or that a special condition be included that documents the arrangements.
- Allow extra time for finance to be approved. If you are borrowing money, the documentation and approval process is much more complex than for a regular residential property purchase.
- Allow for extra legal fees if you are borrowing through a limited recourse borrowing arrangement as your bank will almost certainly require you to engage a solicitor to review and advise you on the effect of the loan documentation. This fee is not usually included in your conveyancing fee to purchase the property, so you should allow for additional legal fees. Some banks even require you to engage a solicitor with a particular number of years of practicing experience so you should check this in advance.
If you are considering purchasing a property through your SMSF, please contact our property law experts today.