SMSF property: the compliance rules the ATO checks
Property is one of the most common assets in self-managed super funds, and one of the areas where trustees most often get into trouble. The ATO and your auditor look closely at SMSF property every year. These are the rules that matter.
The sole purpose test
An SMSF must be maintained for the sole purpose of providing retirement benefits to its members. That means no one, including members and their relatives, can get a current-day benefit from the fund’s property:
- members and relatives can’t live in a residential property owned by the fund, even briefly or at market rent,
- the property can’t be used as a holiday home by anyone connected with the fund,
- members can’t use it for storage or other personal purposes.
Buying from and leasing to related parties
- Residential property can’t be bought from a member or related party, and can’t be leased to one.
- Business real property, meaning land and buildings used wholly and exclusively in a business, is the exception. The fund can buy it from a member or related party at market value and lease it to a related business at market rent. See should I transfer my business property into my SMSF?
Market rent, on time, under a lease
Where the property is leased to a related party (business real property), there must be a written lease on commercial terms, rent must be at market rates, and it must actually be paid on time. Rent holidays, discounts or letting arrears build up are compliance breaches, and rent below market can create non-arm’s length income.
Market value every year
The fund’s accounts must show the property at market value each year, supported by objective evidence. A formal valuation by a qualified valuer is advisable when the property is acquired, when there’s a significant event, or when markets move, and many auditors expect one at least every few years.
Borrowing
An SMSF can only borrow through a limited recourse borrowing arrangement (LRBA):
- the property is held in a separate bare trust until the loan is repaid,
- the loan can only be for a single acquirable asset (one title, or identical assets bought together),
- if the loan is from a related party, its terms must be arm’s length, following the ATO’s safe harbour terms, or the income may be non-arm’s length,
- borrowed money can’t be used to improve the property.
Repairs versus improvements
Inside an LRBA, borrowed money can pay for repairs and maintenance, but not improvements that change the asset’s character, such as a major extension or turning a house into flats. The fund’s own cash can fund improvements, but if the change creates a “different asset” while the loan is in place, it can breach the rules. Get advice before any significant work.
Expenses must be paid by the fund
All the property’s expenses, including rates, insurance, repairs and agent fees, must be paid from the fund’s bank account. Members paying fund expenses personally is effectively an unrecorded contribution, and can count against the contribution caps. And all rent must go into the fund’s account, not a member’s.
Non-arm’s length income (NALI)
Income the fund earns from dealings that aren’t on commercial terms is taxed at 45% instead of 15%. Common triggers: below-market rent from a related tenant, related-party loans on non-commercial terms, and a member or related party providing services to the fund for free or at a discount.
The in-house asset rule
No more than 5% of the fund’s assets can be in-house assets, such as loans to, investments in, or leases to related parties (other than business real property). Breaching it requires a plan to fix it within a set time.
What auditors find most often
- Rent not paid, paid late, or below market
- Expenses paid from members’ personal accounts
- Property not valued at market value
- Related parties using residential property
- LRBA paperwork incomplete, or the bare trust not set up correctly
- Improvements made with borrowed money
Getting it right
Breaches can lead to penalties for trustees personally, and serious breaches can make the fund non-complying. Our SMSF Specialist can review your fund’s property arrangements, and our SMSF administration ($295 + GST a month) keeps the records, valuations and paperwork in order for the annual audit.