A guide to property investing with a Self Managed Super Fund (SMSF)

Rules to consider with SMSF property investing

Can you sell property to your self-managed super fund?

The answer depends on a number of factors:

• what type of property it is; and
• what will happen after your fund buys it (ie, who will rent it from the fund?).

To understand these rules we have to firstly understand ‘related parties’.

Understanding related parties when it comes to SMSFs

There are strict rules about the sorts of things self-managed super funds can buy from "related parties". The term "related party" has a specific definition when it comes to superannuation but as a general rule it includes the members and trustees of the fund, their family and other entities they control (for example a company or a family trust controlled by the member and/or their family).

Can your SMSF buy residential property from yourself or family?

When it comes to buying property, SMSFs can't buy property from related parties unless it meets another definition – it has to be "business real property". Generally, business real property is exactly as it sounds, a commercial property such as an office building or factory rather than a home.

So, if the property you already own is (say) a holiday house or residential investment property, the answer is no. And it wouldn't matter whether it was owned directly by the member and/or their family or by their family trust, all would be related parties and so the same rules apply to your property purchase. Learn more here.

The (very limited) residential property exception

There is one exception which is fairly unusual. Some people run businesses involving residential property – for example, a farm (where the owners also live), businesses that buy and sell properties or they own so many properties that their activities in renting them out are classified as a business. When the residential property in question is part of that business, it can be classified as business real property and so can be sold to the member's fund.

But to be classified as a business, the activity has to be pretty substantial – unfortunately one property rented out via AirBnB is unlikely to be enough to qualify under this exception.

So for most people, it's not possible to sell a residential property they already own (directly or via some other structure) to their SMSF.

Can you use the property owned by the SMSF?

Your SMSF can own residential property but it would need to buy it from someone entirely outside the family. And there's another catch. Even if the property is bought from a genuine third party, it can't be rented back to the family either. That's because SMSFs can't normally lease assets to related parties. In fact, say the property was a holiday house, it couldn't even be used occasionally by the family.

SMSFs and Commercial Property – the rules are different

But what about commercial property (business real property)? The position is entirely different here. Not only can the fund buy it from a related party, it can also lease it back to (say) the family business. 

There are more rules to be careful of here with commercial property. For example, the lease would need to be completely commercial. This would include charging an appropriate amount of rent, making sure it's paid regularly, increasing it in line with the rental agreement and normal commercial terms, making sure the tenant (the family business) and landlord (the fund) both pay the costs that would normally belong to each of them and more.

When it comes to purchasing commercial property, the arrangement also needs to be entirely commercial. For example, it would be a problem if the fund didn't pay enough for the property or if it paid too much. Similarly, take care with the terms of the sale – is the deposit paid consistent with normal commercial sales? And the settlement period?

The consequences of getting SMSF property transactions wrong

If your self-managed super fund doesn't get this right, there can be very serious consequences.

For example, if it doesn't look like the super fund is receiving a commercial amount of rent (say the business is paying too much), any income the fund receives (for example the rent on your property) will be classified as "non arm's length income" (often called NALI). Non arm's length income is a real problem – it's taxed at the top marginal rate rather than the usual super fund rate of 15%. And that can even apply to any capital gains the fund makes when the property is eventually sold.

All sorts of things can cause SMSFs to have a non arm's length income problem with their property – not paying enough for it in the first place, receiving too much rent or even incurring expenses that are lower than commercial terms. Artificially low expenses can be more common than you'd think. What if the family business – as the tenant of your property – pays for things the fund should pay for? That would be a problem. Or even having the members do things like major work on the property that the fund doesn't pay for can be a problem.

There are definitely traps to watch out for when you invest in property with an SMSF and it's important to get advice.

Other ways to transfer commercial property

Providing all these are taken care of, though, there's no reason your SMSF couldn't buy business real property that is already owned by its members. In fact it could even be given to the fund as a contribution (rather than the member receiving cash) or the fund could borrow to buy the property under a special "limited recourse borrowing arrangement (LRBA)". This is definitely an area where it pays to get advice first as there are more rules and limits on contributions and these types of borrowings for the property.

Don't forget the documentation

All SMSFs need to operate in line with their trust deed and investment strategy. It's unlikely a trust deed would prevent a fund from buying business real property from a member but it's worth checking. If the fund hasn't owned a lot of property before and the property being purchased will represent a large proportion of its investments, it's likely this will reflect a big change in the trustees' investment strategy – they should update their documentation to make sure it's clear this has been a conscious decision.

The most important question about SMSF property investments

Finally, before even considering any of these specific rules the trustees should ask themselves one key question: why is the property being bought with the SMSF in the first place?

Remember, all super funds exist for the sole purpose of helping their members save for retirement and protecting their family should they die. Everything the trustees do with their SMSF has to be checked against this "sole purpose". If the real reason you want to sell a property to your fund is because you need the cash or you feel it would be good for your business, you may well be breaking one of the most fundamental rules of super – the sole purpose test.

Can you renovate the property yourself?

Let's explore what happens when SMSFs don't pay an arm's length price for services on their property.

A practical example of SMSF property maintenance

We'll use the example of Kate's SMSF (she's the sole director of the corporate trustee) which owns a residential property. She rents it out to people she doesn't have any connection to (for example, they're not members of her family). Kate pops in every now and again to check the tenants are looking after the property and she often does the odd repair while she's there.

Unless Kate actually runs a business doing that kind of work (and let's assume she doesn't), her SMSF can't pay her for her time in checking the premises and doing the repairs. There are rules that prevent super fund trustees being paid from the fund unless they're providing services they genuinely offer to the public.

What's allowed as trustee duties?

So at first glance, it sounds like Kate's SMSF might have a problem. But in fact, as a director of the trustee of the fund, Kate is allowed to (and in fact should) carry out her "trustee duties" at no cost to her fund. It's highly likely that a modest amount of work like the things described here on the property would be fine.

When does work on the property become a problem?

But what if Kate did something more major to the property? She's actually a retired builder and she used her skills to knock out a few walls and create a new open plan kitchen / dining area plus added a deck outside. There, we have a problem. This goes well beyond just minor repairs and the conventional "trustee duties" for the property. Kate has done some valuable work that the fund hasn't paid for and improved the value of the property. That creates the risk that future rent and capital gains on this property would be classified as "non arm's length income" (NALI). NALI is taxed at 45% rather than the usual 15% for super funds.

Could renovations to the property be treated as a contribution?

It might be possible to instead treat this as a "contribution" by Kate to her super fund (ie instead of giving her fund cash, she gave it a boost via the renovations to the property). But unfortunately this is a little grey at the moment as the ATO is revising its rulings on this type of transaction. And even if this was a solution, it's worth noting that the "contribution" wouldn't just be the value of Kate's labour and materials, it would be the full increase in value of the property. And it would be subject to the usual caps on contributions.

The building materials trap

Unfortunately, things could even get worse with the property renovations. Who paid for the materials Kate used? If she used supplies such as wood, bricks, tiles she had left over from previous jobs, the fund has also acquired assets (these supplies) from her or her building business. Even if her fund paid for them eventually, technically they were still "acquired" from Kate or her business. In super parlance, Kate and her business are known as "related parties" of her SMSF and only very specific types of assets can be acquired from related parties. Building supplies are definitely not on the list. Her fund will have broken the super law.

What if family members work on repairs to the property?

What if it wasn't actually Kate that did some work but instead it was her father Max? Now it's even worse. Kate can't even argue that minor repairs are just part of her trustee duties because she's not doing them – her father (who's not a trustee) is.

The safe approach to improving property

If this was my SMSF’s property I wouldn't be doing the renovations myself – I'm nowhere near as handy as Kate. So I'd pay someone else to do them. But what if I (unpaid) actively supervised and perhaps did a bit of the painting on my property? That's likely to be fine. It's entirely reasonable that a prudent trustee would supervise work being done on a fund asset.

The bottom line on holding property in your SMSF

This can be a fraught area for self-managed super funds with property where the trustees are used to actively working on properties they own personally in order to enhance their value. Life is just not as simple for property in an SMSF as it is for a personal one. Sometimes things it makes perfect sense to do with your own property can create significant tax or compliance problems when it comes to an SMSF property.

You may also be interested in...

• Investing in collectables
• Shared investing in an SMSF
• Borrowing to invest
• Thinking about investing overseas with an SMSF