Human nature is an interesting thing. I source a lot of my best behavioural insights from social media forums where self-congratulations about investment successes are shared freely in the guise of a question.

But you never hear the horror stories, the riches-to-rags disasters such as losing all their super on the FTX Crypto platform where multiple crypto wallets were supposed to provide diversification; or a property investment in the outer metropolitan reaches on the promise of new infrastructure, growth corridor, you name it. The genius scriptwriters at Utopia couldn’t script these disasters better.

So, this column is urging a responsible approach to running an SMSF. You need to fulfil your obligations to your members (including yourself). Remember, as an SMSF trustee you have a fiduciary duty to do the right thing by members and beneficiaries (that’s right, you have an obligation to act responsibly for your children, who may or may not be members of the SMSF – this is enshrined in the SIS Act).

Property Misperceptions

It’s more complicated than many think, so I am going to share some thoughts and observations on common misunderstandings, chiefly on SMSFs looking to invest in property.

• While the adage of location, location, location still applies to selecting property, when it comes to structuring the purchase, investors need to forget most of what they know because much of it probably doesn’t apply when using an SMSF.
  
  
• Understand the SIS rules and regulations; there is a lot of interaction between sections, and the answers are never straightforward. Remember that when you set up an SMSF you sign a declaration stating that you know everything there is to know about running an SMSF and the regulator will hold you to it – and administrative penalties apply if you don’t.
  
  
• You can’t buy a residential investment property owned by any of the following: Yourself, or anyone related to you, or any companies or trusts that you, or anyone related to you, controls. If anyone tells you that you can transfer residential property into your SMSF through a series of moves, trusts, etc., they are either lying to you or they don’t understand the rules. Section 66 of the SIS Act which prohibits the acquisition of assets from a related party has an anti-avoidance provision s66(3), a catch-all that implies if you enter into a scheme to get around the rules and are caught there is the potential for massive fines to apply (monetary penalties of up to 2000 penalty units @$313 or $626,000 per trustee, paid personally and not recoverable from the SMSF, and up to one year’s jail).
  
  
• You can never use a residential property owned by your SMSF and this includes renting it to any of your relatives, even if you have a formal lease in place charging market rates.
• If you buy a beach house, the same rules apply: you or your relatives can never stay there. You can’t even use the garage for storage as that’s still considered personal use. To those who say, “Who’s going to know”, I reply, “Is a hefty fine or jail worth the risk?” Interestingly, trustees can stay in a property for a short period to do maintenance, but regulatory eyebrows will be raised if that maintenance occurs during Christmas and New Year.
  
  
• Having lots of investment properties doesn’t suddenly change the properties from residential to commercial to qualify as business real property under this exception in SIS Act s66(5). The ATO has specific rules about what it means to be in business and the passive collection of rent is unlikely to meet them.
  
  
• If you intend to use a Limited Recourse Borrowing Arrangement (LRBA) to build your SMSF property investment portfolio you cannot cross-collateralise SMSF property (i.e. buy a property and wait until it grows in value and then buy another using both as security for the next loan). You must build equity via surplus income and contributions (or rolling in new members) and then establish a new bare trust with a new loan for each property. The only concession is you can use the same bare trust trustee for the new trust.
  
  
• If you are using an LRBA to fund your property investment via an SMSF, the loan proceeds must be used to buy a single acquirable asset, and, while the loan is in place, you cannot change the character of the asset. This means you can’t:

a) Subdivide it.

b) Buy vacant land and later borrow more to build a house on it. The single acquirable asset is the land. This can only be achieved under a single land build contract.

c) Buy a house and demolish it to build a warehouse; conversely, you can’t convert a house into an office or consulting room.

All of these change the character of the asset – and are not permissible. But you can buy a small house and enlarge it to increase its capital value and income potential because you haven’t changed the character of the asset; it’s still a house. Remember, though, the improvements must be paid for by cash in the fund and not debt.

Property investment is complex, and we haven’t even considered property development and joint venture arrangements. For those interested the ATO has just released Taxpayer Alert TA2023/2 addressing its concerns with these arrangements.

No matter how experienced you are with property as an asset class, the moment you consider an SMSF to manage your retirement savings you should get advice from a licensed financial adviser. Even better to seek out an SMSF Specialist Adviser (SSA)TM

Most importantly, listen to the advice, even if it’s not what you want to hear. Sometimes the best advice is “no”. Equally, it’s important to understand that with an SMSF the answer is probably not “no” but “no, not yet”.

Make additional contributions to build your retirement savings to a point where an SMSF is viable from a cost perspective. An SMSF does offer great investment opportunities, but only for those who are fully cognisant of their responsibilities and, when necessary, are willing to take advice.