In this guide
Last month we looked at the various options available to self-managed super funds to invest in the property market. Our property series continues this month, focusing on business real property and opportunities around owning business real property through an SMSF.
We will also look at specific rules that need to be followed and ongoing compliance considerations for SMSF trustees when holding business real property.
Background
Where a property meets the requirement to be business real property, it opens up certain opportunities for SMSF trustees, including the following two main benefits:
1. Acquiring assets from a related party
SMSF trustees are usually prohibited from acquiring assets from the members of the fund or from the funds related parties. This prohibition extends to assets that are either purchased by the SMSF or assets that are transferred into the fund as in-specie contributions.
An exception to this rule exists for property that meets the requirements to be business real property, so long as the transaction is carried out using the market value for the property and on arms-length terms.
This allows members of an SMSF to move existing business property that they may own personally, or through other entities like trusts or companies, into their SMSF. This could potentially provide significant tax benefits around the receipt of ongoing rental income and on any future capital gain when the property is sold.
2. Leasing the property to a related party
The in-house asset rules contained within superannuation legislation apply a 5% limit on fund assets that are leased to related parties.
However, business real property is excluded from the 5% in-house asset limit, allowing a related party business to rent these premises from the SMSF.
Learn more about the in-house asset rules here.
What is business real property?
Business real property refers to freehold or leasehold land that is used wholly and exclusively in carrying on a business.
When applying the business real property test, we need to look at the underlying land and what that land is being used for.
Examples of business real property might include:
- A commercial office space used by a professional to run their business
- A warehouse or factory used entirely in a business
- A rural property on which a primary production or farming enterprise is carried out.
It is important to note that the business use of the property is not limited to businesses owned or operated by the SMSF members. The property could be used by an unrelated party in their business and still meet the requirements to be business real property.
Example
Andrew is a member of his family SMSF and for the last five years he has personally owned a freehold commercial office space that he has rented out to an unrelated accounting firm.
Andrew therefore owns an eligible interest in land that is used wholly and exclusively in one or more business.
As the property meets the requirements to be business real property, Andrew could sell the property to his SMSF so long as the transaction is carried out at market value.
When residential property meets the brief
A common misconception is that only commercial property can qualify as business real property. This is not always the case.
Residential property can meet the requirements to be business real property so long as two basic conditions are met:
- There needs to be an eligible interest in real property, being either a freehold or leasehold interest
- The property must be used 'wholly and exclusively' in one or more business.
Examples of when residential property could meet these conditions include:
- A residential property used wholly and exclusively by a doctor as their surgery
- A residential property used wholly and exclusively as a real estate agent's office
- A block of land owned by a property developer currently being held for a future development
- Where the property is one of many other residential properties owned and operated as part of a property management or property investment business.
The following example is taken from the ATO SMSF ruling on business real property:
Case study
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.
The scale of the operation together with the elements of repetition and purpose indicate that Mr Wood is carrying on a property investment business.
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.
