One reason for the popularity of self-managed superannuation funds (SMSFs) is their ability to hold assets that cannot be held in traditional superannuation funds, such as direct property.
Subject to the investment being undertaken with reference to the fund’s investment strategy and the sole purpose test, there can be real advantages to transferring business property into a SMSF.
Business real property, in relation to an entity, means:
a) any freehold or leasehold interest of the entity in the real property; or
b) any interest of the entity in Crown land other than a leasehold interest, being an interest that is capable of assignment or transfer; or
c) if another class of interest in relation to real property is prescribed by the regulations for the purposes of this paragraph — any interest belonging to that class that is held by the entity;
where the property is used wholly and exclusively in one or more businesses (whether carried by the entity or not), but does not include any interest held in the capacity of a beneficiary of a trust estate.
Business real property in a SMSF
While the Superannuation Industry (Supervision) Act 1993 (SIS) limits the purchase of assets from SMSF members and related parties, business real property is specifically excluded from this rule, along with listed securities, widely held unit trusts and pooled superannuation trusts.
The purchase of business property by a SMSF from a related party, however, must be transacted at market value. To meet this condition, it would be necessary to acquire a property valuation.
A lease agreement between a SMSF and a related party, where the asset being leased is business property, is exempt from the in-house asset rule.
Stamp duty and legal costs
Stamp duty costs must be considered when recommending property transactions. Likewise, consideration should be given to the impact of legal costs, including the sale contract and the lease agreement between the SMSF and the related party.
Case study
John and Mary Webber* run their own SMSF. John, age 51, is a surgeon with his own practice. Mary, age 49, is a practice manager. The case study demonstrates an example of a business owner transferring a business property to a SMSF from a family trust.
Details of J & M Webber Family Trust
- The beneficiaries include John, Mary and their two sons. Their sons are working full-time, therefore, the tax benefit of distributing trust income to them has diminished.
- The family trust holds a direct property (John’s rooms). The property has been valued at $550,000 (by a registered valuer) and meets the definition of business real property.
- John makes rental payments to the family trust for use of the rooms.
- The cost base of the property is also around $550,000, meaning capital gains tax (CGT) is not a concern. The timing of the transfer is important for CGT purposes. In situations where a capital gain is realised, funds need to be set aside to meet the tax liability. If the likely gain is large, it may be unattractive to move the property into superannuation.
- The property currently has a mortgage of $420,000, which will need to be discharged prior to transfer into superannuation.
- Details of J & M Webber Superannuation Fund
- John and Mary are both members and trustee directors.
- As retirement nears, they wish to build assets within the concessionally taxed super environment.
- The SMSF holds the majority of funds in cash and managed funds.
Recommendations
1. Property transfer from family trust to SMSF
John and Mary will continue to operate their business from the premises until retirement.
Property was transferred into the SMSF from the family trust. An amount of $550,000 cash was paid to the family trust from the SMSF to purchase the property.
The cash received from the SMSF was used to pay down the loan on the property ($420,000), allowing it to pass to super unencumbered, avoiding a breach of SIS borrowing restrictions.
Stamp duty of around $22,000 is borne by the SMSF as the purchaser.
John signed a new lease agreement (incurring some legal costs) with the SMSF to continue renting the premises.
Superannuation is a tax-effective structure in which to hold the property for a number of reasons, including:
- Capital gains realised on the property will be taxed at 15 per cent, with a one-third discount if the asset is held longer than 12 months (effective rate of 10 per cent) and sold while in the accumulation phase of superannuation.
- As the property will be retained at least until retirement, disposal is likely to occur after John and Mary have commenced pensions and will not be subject to CGT.
- Rental income paid by John is captured at the superannuation tax rate of 15 per cent as opposed to it being distributed via the family trust to individuals on a higher marginal tax rate (minimum 31.5 per cent). Rental payments remain tax deductible to John. These tax benefits are illustrated in the table below.
- If the property was leased during retirement with John and Mary in pension phase, rental income will be received tax-free within the SMSF.
2. Part of sale proceeds returned to John and Mary
- The family trust receives $550,000 cash. Of this, $420,000 is used to pay down the debt attached to the property, allowing it to pass to super unencumbered.
- The remaining funds may be invested in other assets or returned as trust corpus, depending on the trust deed.
- If John and Mary required the funds, the strategy could enable a release of cash that would otherwise be preserved.
3. SMSF investment strategy and diversification
- If direct property is going to be part of the SMSF portfolio, the investment strategy must allow for this and show how it will help meet the trustee’s retirement objectives.
- It is not ideal to hold the bulk of SMSF assets in a single direct property. With the remaining fund assets plus additional contributions, a portfolio was established to achieve diversification within the SMSF.
*Not their real names.
Always refer clients to a qualified accountant to obtain specialist tax advice when dealing in this area. For further information regarding business real property in SMSFs, please refer to the Australian Taxation Office document SMSFR 2009/1 Self Managed Superannuation Funds: business real property for the purposes of the Superannuation Industry (Supervision) Act 1993.
Brian Daly is an associate adviser at Centric Wealth.
