Property purchased through an SMSF cannot be lived in by the member, any other trustee or anyone related to the trustees — no matter how distant the relationship.

It also cannot be rented by the member, any other trustee or anyone related to the trustees. So, buying a holiday home in an SMSF and living there during the summer is not allowed.

There are no restrictions on buying property overseas. However, the trustees would need to be satisfied that the purchase still meets the sole purpose of providing retirement benefits for its members, or death benefits to a member’s beneficiaries if they die.

Trustees will need to consider the strength of the property market in the overseas market (is the property likely to grow in value?), the risk of investing in the overseas market (is the overseas country politically and economically stable?) and the potential implications of currency fluctuations (is growth in the value of the property likely to be wiped out by currency movements?).

Practicalities would also need to be considered; does the overseas legal system recognise an SMSF as an entity that can buy property?

Investing in commercial property

Generally speaking, investing in commercial premises through an SMSF has some advantages over residential properties. Commercial properties can, for instance, be sold to an SMSF by its members as well as be leased to SMSF trustees or an individual or business related to them.

To purchase a commercial property in an SMSF, a fund may apply for a specific SMSF loan. However, the criteria are stricter than traditional lending, with tighter loan-to-value ratios.

Many small business owners use their SMSF to purchase a business premises and then pay rent directly to the SMSF. It’s important to get this right; the rent paid must be at the market rate (no discounts) and must be paid promptly and in full at each due date.

The investment must also satisfy the overarching function of the SMSF, which is to provide retirement benefits for its members (the sole purpose test). Therefore, the trustees must ensure the purchase provides a retirement benefit for the members. Trustees will need to consider the yield and expected growth in property value. If the property doesn’t shape up, they may need to reconsider the purchase.

When it comes to leasing the property to a related party, it must be done on the same terms as it would with an independent third party. A lease arrangement needs to be in place, clearly outlining the terms and conditions that match standard commercial agreements. Market rate rent will need to be paid regularly and physically into the SMSF bank, and the property will need to be periodically independently valued.

Borrowing to buy property in an SMSF

Borrowing to buy property through an SMSF is achieved through a limited recourse borrowing arrangement (LRBA).

To “limit the recourse” of the lender, a separate property trust and trustee is established to hold the property on behalf of the super fund, outside the actual SMSF structure. All the income and expenses of the property go through the super fund’s bank account. The super fund must meet all loan repayments. If the super fund fails to do this, the lender only has the property held in the separate trust as recourse, and cannot access any remaining assets of the super fund.

Borrowing criteria for an SMSF is generally much stricter than a normal property loan that might be taken out as an individual. The loan also comes with higher costs, which needs to be factored in when working out if the investment is worthwhile.

Compliance

SMSFs need to value all of their assets at market value, and the valuation needs to be based on objective and verifiable data. If an SMSF holds commercial property, a real estate agent or registered valuer will need to provide an independent valuation.

If the commercial property produces a gross rental income in excess of $75,000 per annum, the fund will also need to register for GST. Once the SMSF is registered for GST, it can claim 100 per cent of GST on any expenses associated with the commercial property.

Once the property begins to produce a rental income, it will be taxed at 15 per cent. If the property is sold (after owning it for more than 12 months), 10 per cent capital gains tax will apply. If the SMSF is in pension phase and the sale fits within the member’s balance cap, then no capital gains tax is payable.

It is up to the trustees to make themselves familiar with what they can and can’t do, as the ATO will hold the trustees responsible.

There can often be expensive repercussions for not quite getting it right — from trustee penalties issued by the ATO to stamp duty implications.

All trustees are personally liable for any decisions made by the fund, even if they engage a third party to assist or another member/trustee makes a decision.  

Mark Chapman, director of tax communications at H&R Block