In this guide
One of the unique characteristics of self-managed superannuation funds (SMSFs), which make them attractive to some investors, is their ability to invest in direct property.
According to the Australian Taxation Office (ATO), a significant number of SMSFs do indeed invest in direct property. As at December 2022, approximately 9.3% of all SMSF assets were invested in non-residential property (approximately $78 billion) and another 5.1% (approximately $43 billion) were invested in residential property.
Although it has its benefits, investing in property in an SMSF can be complicated and should never be considered as an easy way to enter the property market.
The rules
Just like any other asset in which an SMSF invests, and perhaps even more so if the property asset is to represent a large chunk of the SMSF portfolio, a property needs to meet the sole purpose test. That means the SMSF, and therefore the investments it invests in, needs to be maintained for the sole purpose of providing the members (and their dependents if the members are deceased) with retirement benefits.
There are some exceptions for SMSFs around incidental benefits, as stated in the below extract from SMSFR 2008/2 ruling.
Nevertheless, the provision by an SMSF of benefits other than those specified in subsection 62(1) that are incidental, remote or insignificant does not of itself displace an assessment that the trustee has not contravened the sole purpose test. As set out at paragraph 5 of this Ruling, determining whether benefits are incidental, remote or insignificant requires the circumstances surrounding the SMSF’s maintenance to be viewed holistically and objectively.
Related parties and in-house assets
If you are considering acquiring a property from a related party for your SMSF, there are very specific conditions under which you can do so. You can only acquire a property used wholly for business or farming purposes and only at market rates.
To recap, related parties include the below.
- The relatives of each member
- The business partners of each member
- Any spouse or child of those business partners
- Any company the member or their associates control or influence
- Any trust the member or their associates’ control.
Employers who contribute to your superannuation and associates of employers who do so (business partners and companies or trusts the employer controls and companies and trusts that control the employer) are also related parties.
The exceptions to these rules include acquiring business real property. A business real property is defined as land and building that is used wholly and exclusively in a business. It can apply to agricultural property in some instances – even if there is a residential home on the property – if the dwelling is in an area of land no more than two hectares and the main use of the whole property is not for domestic or private purposes.
Other exceptions include acquiring in-house assets – providing the value of the in-house asset does not exceed 5% of your fund’s total assets. That requirement alone rules out residential property for the majority of funds, which would have to be very large for a direct property investment to be less than 5% of total assets.
Related parties and SMSF members are able to rent or lease business and farming property investments from SMSFs but not residential property owned by SMSFs. All leasing of properties by SMSFs also needs to be at commercial rates, that is, arm's-length arrangements.
A case study
A recent case – between the ATO and an SMSF – emphasises the importance of motive when it comes to understanding the sole purpose test. It is an illustrative example of both the application of the sole purpose test and the in-house asset definition.
In the Aussiegolfa Pty Ltd (Trustee) v. Federal Commissioner of Taxation case, Aussiegolfa Pty Ltd was the trustee of the Benson Family Superannuation Fund (Benson Fund), an SMSF that invested in a managed investment scheme, the DomaCom Fund. Benson Fund acquired units in a sub-fund of the DomaCom Fund, the ‘Burwood Sub-fund’. That fund acquired a property in Burwood, Victoria. The ownership of that fund was represented as follows:
- 25% by Aussiegolfa Pty Ltd as trustee of the Benson Family Superannuation Fund
- 50% by the mother of a member of the fund
- 25% by the sister of the member of the fund and her husband.
The DomaCom Fund entered into an arrangement with Student Housing Australia Pty Ltd (Student Housing Australia) to lease the Burwood property. The initial tenants were third parties who were not related parties, however Student Housing Australia then decided to lease the property to a daughter of a member of the fund from February 2018.
The rental arrangement was on the same monthly rental that was paid by the previous two tenants i.e. still at market rates. The value of the units in the DomaCom Fund constituted 7.83% of the total assets of the Benson Fund at market value. Therefore, it was in breach of the in-house asset rule as more than the 5% of the fund was invested in a unit trust that leased the property to a related party. However, if the investment in the trust was considered to be in a widely held unit trust, it would be excluded from the definition of ‘in-house asset’ in terms of the SIS Act.
Following a determination by the ATO, the matter was referred to the Administrative Appeals Tribunal. Its decision – that the units held by Aussiegolfa Pty Ltd in the Burwood Sub-fund did constitute an in-house asset of the Benson Fund and the lease of the Burwood property to the daughter of the member was in breach of the sole purpose test – was appealed by Aussiegolfa.
A final decision in the Full Federal Court was that the leasing of the property was not in breach of the sole purpose test and that the units held in the Burwood Sub-fund were in-house assets of the Benson Fund.
The ATO has issued a Decision Impact Statement here.
This decision impact statement suggests that the ATO views the decision as not necessarily a precedent and that each case like this will be considered on their merits.
However, for the sole purpose test it does highlight the importance of motive when benefits, other than superannuation benefits, are determined to be incidental or not.
“In the case the decision seems to be influenced by the fact that the student accommodation was leased firstly to arm’s-length tenants at market rents and subsequently leased at market rents to a related party,” says SuperConcepts executive manager, SMSF technical and private wealth, Graeme Colley.
“The decision was that the original motive of the trustees was not altered by the change in tenants from arm’s length to related party. However, had the rent paid by the related party been on a different basis then it would indicate the motive may have changed and resulted in a breach of the sole purpose test.”
The case is also instructive when it comes to understanding the difference between an in-house asset and a widely held unit trust asset. A trust, for this purpose, needs to be held more widely than by three interrelated parties, which was the case in Aussiegolfa.
