Approximately 10% of SMSFs own commercial property and often this commercial property is leased to a related party (eg a business owned by the members of the fund). If you have employed a similar strategy with your SMSF, there are a number of rules to follow to ensure the arrangement complies with the superannuation / tax laws.
Commercial Lease Arrangement
Where property is leased to related parties, it is vital to ensure the lease arrangement between the fund and the related party is on arm’s length terms and conditions. This simply means that the terms and conditions of the transaction must be the same as they would have been had the parties not been related.
To ensure your lease arrangement meets the rules, as trustee of your fund, you would generally need to:
- before the arrangement commences, obtain a third party written opinion of the market rental to be charged on the property,
- enter into a written lease agreement with the related party on normal commercial terms. For example, the agreement should:
- specify the term of the lease agreement
- require the payment of rent as per the third party opinion obtained,
- specify how often rent should be paid (usually monthly) and what action will be taken if rent is not paid on time,
- specify who (eg lessor or lessee) will be responsible for the payment of rates, insurance etc (the third party opinion obtained will usually specify who should be responsible for these costs), and
- specify when the rental amount should be increased with CPI or reviewed to market etc,
- ensure all transactions are in accordance with the lease agreement. For example:
- if the lease requires rent to be paid on a monthly basis, the fund trustee should ensure the fund receives the rent on a monthly basis,
- if the lease requires costs such as rates, insurance etc to be met by the lessee, the fund should not ultimately bear these costs, and
- if the lease requires the rent to be increased with CPI on each anniversary of the lease, the rent should be appropriately increased.
- ensure any insurance policies over the property are registered in the name of the fund, or where in the name of the lessee, the fund should be noted as an interested party on the policy, and
- if appropriate, renew the lease agreement on its expiry based on an up-to-date third party opinion of the market rental to be paid etc.
As part of the annual audit process, the fund’s auditor will generally wish to review the lease agreement and the third party written opinion of the market rental.
Business Real Property
SMSFs are generally not permitted to lease real property to related parties (eg members of the fund, relatives of members, entities controlled by members/relatives) unless the property is used “wholly and exclusively” in a business. “Wholly and exclusively” means there generally can’t be any personal use of the property, although there are some exceptions for property used in a primary production business.
You need to ensure the property continues to be used wholly and exclusively in a business throughout the duration of the fund’s lease arrangement with the related party.
Importantly, property like plant, equipment, motor vehicles, water rights that can be dealt with separately from the land etc are not “real property”. If these sorts of assets are owned by an SMSF and leased to related parties, they are called “in-house assets”. The total amount an SMSF invests in in-house assets is not allowed to exceed 5% of the total value of the fund’s assets.