SMSFs investing in property: Tips and traps

Many SMSF trustees contemplate investing in real property as part of the fund’s investment strategy. However, a Tax Office notification has raised concerns that some trustees may not fully consider the risks and issues associated with holding a real property investment and how this can affect other aspects of the fund, such as benefit payments.

The Tax Office’s notification alerted trustees to consider the following issues.

Investment strategy

Trustees are required to invest in accordance with the investment strategy of the fund, including giving regard to liquidity. When deciding whether to invest in property, trustees should consider if this meets the diversification and liquidity requirements of their fund. For example, when members retire and start receiving pensions, there needs to be sufficient money in the fund to meet minimum pension payment requirements.

Borrowing

Superannuation law allows a fund to borrow only in limited circumstances. When an SMSF borrows money to invest in property, it needs to do so via a limited recourse borrowing arrangement (LRBA). These borrowings need to be made on commercial terms to avoid adverse income tax consequences, such as income being deemed non-arm’s length income that would attract non-concessional tax rates.

Related party transactions

In the case of the property being leased to a related party, trustees need to ensure compliance with the super laws, such as:

  • in-house asset rules
  • sole purpose test
  • arm’s length requirements.

Use of property in retirement

When an SMSF starts to pay a pension, all property investments must continue to be maintained in accordance with super laws, in particular the sole purpose test and in-house asset rules. For example, members are not able to occupy or lease residential property on retirement without the asset first being sold or transferred to the member(s) as a benefit payment. Trustees need to keep in mind that the transfer of any asset from an SMSF to a member must also be permitted under the governing rules of the fund and that a capital gains tax (CGT) event may occur, with possible taxation implications for the fund.

Offshore investments

The Tax Office warns that the risks and issues that are associated with property investments may be heightened when these investments are located in an offshore jurisdiction.

The Tax Office notification says that there is no specific guidance other than the rules of the superannuation laws as to what trustees can invest in regarding to real property, and also emphasised that it is not its role to provide investment advice.

It is important to be mindful that the trustees of any SMSF are ultimately responsible for managing the super fund, so appropriate research and scrutiny should be applied when making investment decisions. The Tax Office encourages trustees to seek professional advice.

Insurance

SMSF trustees also need to seriously consider insurance for their fund to cover unforeseen events. This cover can include:

  • general insurance – trustees should ensure they have adequate insurance to cover property repair or replacement costs in the event that the property is damaged.
  • third-party liability insurance – trustees should be aware that as a property owner, the fund can be sued; this may put the fund’s assets at risk.
  • death or total and permanent disability insurance – trustees should consider the benefit of policy proceeds to assist in meeting ongoing obligations, including where the property is business real property used in a family business.