MLC's Mansi Desai explains how small business owners could transfer a business real property into their SMSF and benefit from various CGT concessions.
A strategy commonly used by small business owners is to acquire a business real property in their self-managed super fund (SMSF) using the fund's existing cash and (usually) money borrowed through a limited recourse borrowing arrangement.
However, it's also possible for small business owners to transfer ownership of an unencumbered business real property that they or their business own into their SMSF by making a partial or full in-specie contribution.
This could be an attractive strategy for owners who are winding up their business and wish to retain an interest in the property.
It could also be used by owners who intend to continue running the business and are looking for a tax-effective way to hold the property.
In both these scenarios, it may also be possible to take advantage of various small business capital gains tax (CGT) concessions that could enable the owners to disregard some, or all, of the capital gain that would be triggered when transferring the property in-specie into super.
But before using this strategy, it's important to understand the transfer rules, some timing issues and how the transaction would interact with the contribution caps.
The transfer rules
Super fund trustees are generally prohibited from acquiring assets from related parties, such as fund members, their family and partners, related companies and trusts.
There are, however, some exceptions outlined in section 66 (and proposed sections 66A and 66B) of the Superannuation Industry (Supervision) Act (SISA). One of these is business real property (eg, a warehouse from which a business is run).
A number of conditions and requirements, which need to be met before a property will be considered 'business real property', are addressed by the ATO in SMSFR 2009/1.
The ATO confirms in ATO ID 2010/217 that a contribution can be made by transferring a business real property to a complying super fund provided the contribution satisfies the SISA provisions. In addition section 285-5 of ITAA 97 confirms that a contribution can be made by the way of an asset.
However, an SMSF cannot acquire an asset that has an existing charge or loan against it. So this means the business real property would have to be unencumbered before it can be transferred to an SMSF.
This strategy could therefore only be used if the property is currently owned outright, or the business owners have other financial resources to extinguish the debt before transferring ownership.
If this strategy is implemented, the property will need to be transferred at market value, and this value will need to be recorded as a contribution in the name of one or more CGT concession stakeholders, where the amount(s) will be counted towards the relevant caps.
In the proposed sections 66A and 66B of SISA, a transfer of business real property to an SMSF from a related party must be undertaken for a value ascertained by an independent and appropriately qualified valuer.
Finally, where the CGT concessions are to be utilised, it is not possible for the contribution(s) to be attributed to SMSF members who don't have an interest in the property prior to it being transferred into the fund.
The timing issues
Some timing issues can arise when attempting to utilise the CGT concessions upon in-specie transferring an asset into super.
In the June 2011 National Tax Liaison Group minutes, the ATO advised that subdivision 152-D of ITAA 1997, which relates to the CGT retirement exemption, does not contemplate that the CGT event, the choice to disregard all or part of the capital gain and the payment, may all take place simultaneously.
In other words, the decision to apply the CGT retirement exemption should follow the actual CGT event.
Conversely, the wording of the legislation does not clearly rule out the possibility that the CGT event, the CGT retirement exemption election and the payment could all take place concurrently. It is therefore reasonable to argue that the requirements are met if at the same time:
- A CGT event gives rise to a capital gain
- A choice is made to disregard all or part of the capital gain under subdivision 152-D
- A contribution application is made to the fund trustee, and
- The in-specie contribution is made.
This can be a highly complex issue, and SMSF trustees should seek professional tax advice where needed.
Interaction with caps
There are a number of factors such as the value of the property, the amount of the gain and the cost base of the asset that will determine if and how the property can be transferred into an SMSF.
If the CGT retirement exemption is claimed, each stakeholder can make an in-specie contribution up to the lifetime unindexed CGT cap of $500,000.
Depending on the cost base of the property, the non-concessional contribution (NCC) cap may also need to be used in conjunction with the CGT cap to complete the transaction. The following case study illustrates the use of multiple concessions and caps.
Example
Catherine (aged 45) runs a successful small business that currently has an annual turnover of $1.5 million and she wants to transfer ownership of the unencumbered business real property that she owns in her own name into her SMSF.
She is attracted to the idea of her SMSF owning the property, as deductible rent can be paid by her business to her SMSF.
The property was purchased 12 years ago for $200,000. It has been independently valued at $1 million and is an active asset, as her business has used it for at least 50 per cent of the time of ownership.
While most of Catherine's capital is tied up in her business, she has more than $150,000 in cash in her SMSF, which could potentially be used to acquire part of the property if required.
Because the property is owned personally and the period of ownership exceeds 12 months, Catherine is eligible for the 50 per cent general CGT discount, which will reduce the taxable capital gain from $800,000 to $400,000. She also claims a CGT retirement exemption of $400,000, which reduces her taxable capital gain to nil.
Finally, ownership of the property is transferred to her SMSF by:
- Making an in-specie contribution of $850,000, of which $400,000 is claimed under the CGT cap (in respect of the CGT retirement exemption) and $450,000 is counted towards her non-concessional contribution (NCC) cap, and
- Arranging for her SMSF to pay her the balance of $150,000 in cash.
By using this strategy, Catherine will retain an interest in her business real property, protect the asset from creditors and qualify for a CGT exemption when transferring ownership of the property.
She will also increase the value of her SMSF, and additional amounts will be paid from her business to her SMSF as deductible rent.
If the significant individual qualifies for the 15-year small business CGT concession, then the indexed lifetime CGT cap of $1.255 million would be available, which could enable a property with a larger market value to be in-specie contributed.
Under this concession the value that can be transferred under the CGT cap is not only the gain but the value of the proceeds up to the lifetime limit.
Mansi Desai is a technical consultant at MLC Technical Services.
