More and more property owners are waking up to the immense possibilities that the SMSF-enabled property purchases bring to the table. Investment in such properties can pave the road for long-term capital growth. But you can work out a smart short-term gain, too, if you change your stance from ‘investing’ to ‘developing’ or ‘improving’ the property.
SMSF-enabled property market
If you are ready to follow certain rules and not spend hours on gaining unlawful entry to the SMSF-enabled property market, many lucrative bonuses may lie in the way for you. As a first, anything and nearly everything you do in the name of such property development or improvement must be diligently recorded.
Arm’s length transaction
Section 66(1) of the Superannuation Industry (Supervision) Act 1993 (SIS Act) meant for the SMSF trustees precludes the purchase of any property except business premises from a related party. The rules pertaining to the Arm’s Length transactions are pretty stiff and penalties levied are heftier under the new penalty regime of the ATO.
How do we deal with a situation where an improvement is being made to a property using money given by a member or a related party? To use an example, let us suppose mom helps in getting the deck repaired. In such an instance, the “doctrine of fixtures” may apply and it says that anything added to the SMSF”s land becomes its part.
Acquisition of significant/insignificant value
If the materials added to the SMSF’s land or property be of a significant value, the same material can be cited as ‘acquired’ by the SMSF property. Such acquisitions from members or related parties are deemed as breach of law and are hence liable for a penalty-levy from the ATO.
It is not hard to decipher then that the amount the SMSF trustees fetch from members or the related parties should not exceed repair expenses or an amount of insignificant value.
In the event of the SMSF property requiring materials for development or improvement or repairs, the ideal way to go is to get them purchased from an unrelated supplier; the amount of purchase payable through the SMSF’s own bank account.
Ideal way to involve a related party
If the members or the related parties have to be involved, the transaction needs to be done keeping an agency in the buying loop. It should look as if the members or the related parties have bought the materials through an agency via a bare trust arrangement which makes the SMSF trustees look like the purchasers of the materials.
Flouting the rules of arm’s length transaction can put the SMSF trustees in dock, and hence, their minds should keep focusing on how best to keep out of the way of ATO’s contravention. Procuring quotes from the third-parties is one way of doing this. An example of trustees facing music from the ATO- If the ATO gets an impression that you have entered into a related party transaction where the terms proposed to you are favourable (for instance, low interest rate or moratoriums), there must be supporting evidence that the benefits you are getting is no more than a party working at arm’s length could have secured.
Property development via SMSF
Undertaking property development can seem like a viable option for the SMSF trustees and in many ways it is, if you know how to go about the task. Foremost is the need to keep a detailed eye on contraventions. Each contract and specification must be drawn keeping this aspect in mind. An SMSF cannot go against its declared investment strategy while entering into property development. As an aside, the SMSF deed shall be revised at each stage, too.
Trustees must also be guarded against budget hikes. They should be in a position to withstand any sudden increase in the budget of development of the property. Ensuring the constant liquidity of their SMSF is a prerequisite.
Trustee serving the SMSF
Let us take up another crucial question- what happens when SMSF trustees take up SMSFs’ work themselves in the capacity of servicemen/servicewomen? Can they seek remuneration for the job in question? For example, let us suppose a trustee also operates as an accountant for his/her SMSF. Now, such a service does not add to the fund’s capital and hence cannot be deemed as a contribution.
The ‘accountant’ in question can escape contravention even if he/she does not seek remuneration from the SMSF fund though it is like undertaking a non-arm’s length transaction.
Four typical ways an SMSF can develop
An SMSF can undertake property development in many ways. These may include, but are not limited to, sole-undertaking, joint venture, intermediary arrangement and development agreement. While SMSFs can borrow for the purpose of repairs or acquisition, they are abstained from borrowing for the purpose of improvement and development. However, you will find out soon that the rules can be bent under certain arrangements.
Sole-undertaking is an arrangement type where an SMSF buys its own land or property and pays for its development itself. In the event of incurrence of additional costs, it meets the shortfall through additional contributions. Borrowing for such ventures is strictly prohibited unless they affirm to sections 67A and 67B.
An SMSF can purchase a land and have a builder develop it; with the aim of distributing the output in two equal parts (or by setting some other term in advance) on successful completion of the project. It is a nice option for SMSFs which are looking to realize the equity maneuverable outside the fund. There are no liquidity worries on the horizon either as the developer himself takes care of all the developing costs. You must, though, be on your toes if the builder you choose happens to be a related party. All that has been discussed about Arm’s length transaction may apply in the given case.
An intermediary trust
An SMSF can also choose to put its ‘trust’ in a unit trust which then buys and develops property on its behalf. It is not difficult to decode that with unit trusts being intermediaries, multiple SMSFs can become investors simultaneously. Important caveat: in-house restrictions may apply in the event of majority of stakes of the trust being held by the SMSF members. The trustee of an unrelated unit trust can borrow for the purpose of construction and development.
Developing via third party
SMSFs can also look towards developing via third party arrangements (related or third-party). This model uses a land owner-developer symbiosis. The land owner gets funding which he otherwise would have been short of and also enjoys full rights over the land. In addition, he only has to pay commission to the developer if the project turns out to be successful. The developer, on the other hand, is equally overjoyed on getting a developable tract to work on without paying any upfront costs.
We are staking our future here….so think twice!
When you make any investment through your SMSF, for the time till the venture succeeds, you are putting your retirement cushion at stake. The implications for you and your family may not be a silent one if your development plan falls flat on its face. So, it is crucial to sit back and ruminate as much as you possibly can before starting. Approach the topic from various directions, think over different aspects and only then go for the ‘property market’ juggler. Of course, if you take care not to misstep there can be great many financial bounties in store for you.