We know that you can acquire commercial property via and SMSF, but what about residential property? Well yes... BUT it depends. The reason why we say ‘it depends’ is because every client who asks us this question will have a unique scenario in mind. We need to look at the details of each scenario to understand if the transaction will be allowed by the Superannuation rules.
The most common scenario for investing in residential property is when the fund will purchase the property from an unrelated party by paying for it in cash or borrowing via a limited-recourse arrangement (LRBA). With this scenario there are no related party issues to consider, as a result the transactions tend to be straight forward.
Generally, an SMSF is prohibited from purchasing residential property from a related party, with the exception of property which satisfies the business real property conditions.
The issue of whether a property could be transferred from a related party (SMSF member or their relative) depends on whether the property could be considered ‘business real property’, and therefore eligible for inclusion in an SMSF.
Self Managed Superannuation Funds Ruling (SMSFR 2009/1*) sets out to explain the meaning and application of the term ‘business real property’ in relation to self-managed superannuation funds and in summary the two basic conditions that must be satisfied are:
- the SMSF or the other entity must hold an eligible interest in real property.
- the underlying land must satisfy the business use test in the definition, which requires the real property to be 'used wholly and exclusively in one or more businesses' carried on by an entity.
Let’s run through a couple of examples set out in ‘SMSFR 2009/1’ to demonstrate how the rules can apply when an SMSF member wants to transfer property they own into their SMSF.
Example 1: Doctor's surgery in residential premises
Fact #1: Dr Mary owns a house used exclusively by her medical practice.
Fact #2: Dr Mary is a member of the Yianni SMSF. Dr Mary, in her capacity as trustee of the SMSF, wants to acquire the house for market value and then lease it back so the medical practice can continue to operate from the house.
Outcome: Although the house was built to be residential premises, it is not used as such. The real property is used wholly and exclusively in Dr Mary's medical practice business. For the purposes of the related party asset acquisition rule in section 66 (Superannuation Rules), the property is business real property of Dr Mary. Once acquired by the Yianni SMSF, it is also business real property of the fund and is therefore not an in-house asset of the SMSF.
Mary is able to sell or contribute the “house” into her SMSF and then have the SMSF lease it back to her medical practice.
Example 2: Residential property held in a property investment business
Fact #1: Mr Wood owns 20 residential units that are leased to long-term residents. Mr Wood manages and maintains the flats on a full time basis living on the income generated from the leases. The units are not mortgaged. Mr Wood would like his SMSF to acquire some of the units rather than sell the units to a non-related party.
Fact #2: The scale of the operation together with the elements of repetition and purpose indicate that Mr Wood is carrying on a property investment business.
Outcome: Even though the tenants use the properties for their own private or domestic purposes, this use remains incidental and relevant to Mr Wood's property investment business. Consequently, Mr Wood's interest in the property on which the units are built is business real property. Provided the acquisition takes place at market value, the units may be acquired by the SMSF without contravening the related party asset acquisition rule in section 66 of the Superannuation rules.
Example 3: Mechanic - home garage
Fact #1: Stuart Japes is a member and trustee of Japes SMSF. Stuart is also a mechanic who works from his home garage and employs two of his friends (both of whom are not members of Japes SMSF) as mechanics.
Fact #2: Stuart wishes to sell the block of land on which his house and garage are constructed to the Japes SMSF.
Outcome: While the property is real property and a business is operating on the property, the property is also partly used as a residential property. The residential use of the property is not incidental and relevant to Stuart's business, it’s also not of a minor or trifling nature. The property is not business real property of Stuart. As a result, he cannot sell the land to his SMSF without the SMSF contravening the related party asset acquisition rule in section 66.
The ATO has numerous guidelines which are helpful in determining whether or not a residential property could be considered ‘business real property’. If you’re the trustee of an SMSF looking to transfer any property to a fund, our super-awesome super team can provide you with some upper-echelon advice!