Expert SMSF insights
SMSFs and Property Development - Via a unit trust or company
By Graeme Colley
This is part three of our series on SMSFs and property development. You can read part one here to get up to speed on what you need to know when it comes to property development, and part two here which shares tips for direct ownership.
For SMSFs with an interest in a property development, there’s another option outside of direct ownership - to own units in a unit trust or a company that undertakes the property development. In comparison to the SMSF directly owning the property to be developed, the SMSF that invests in a unit trust or a company that undertakes the development, may have a greater level of flexibility available. However, there are a number of issues to consider.
If the trustees of an SMSF decide to purchase units in a unit trust or shares in a company that undertakes the development, trustees need to take account whether the ‘in-house assets’ rules apply to the investment. ‘In-house assets’ include any investments, loans or leases that are considered to be related parties of an SMSF.
Under the in-house asset rules an SMSF is required to limit its in-house assets to no more than 5 per cent of the market value of the fund’s total investments. This test is applied just prior to the fund acquiring in-house assets and also at the end of each financial year.
If the SMSF’s investment in the unit trust or company does not come under the in-house asset rules, there may be no limit to how much the SMSF can invest in the unit trust or company. However, what is ultimately invested in the unit trust and company can depend on the fund’s investment strategy. Whether an investment is an in-house asset can be important as it may limit additional amounts being lent to or invested by the SMSF in the unit trust or company. This would occur if the unit trust or company requires additional amounts to assist in financing the property development.
The main issues to determine whether an investment by an SMSF in a unit trust or company is considered an in-house asset will depend on:
- Whether related parties control the unit trust or company. A member, trustee or director of the corporate trustee of the SMSF may be considered as a related party of a unit trust or a company. Control of a unit trust or company, either individually or as a group, means that:
- Related party unit holders have a right to more than 50 per cent of the capital or income of the unit trust; or
- the majority of trustees are accustomed or under an obligation to act as directed by a group of related parties; or
- related parties can remove trustees or appoint a majority of trustees of the trust.
- Whether the unit trust or company has borrowings. If the unit trust or company is controlled by related parties, which includes the SMSF as indicated earlier, the investment will be included in the in-house assets of the SMSF and the total in-house assets will be limited to 5% of the market value of the fund.
If related parties do not control the unit trust or company, then the unit trust or company can borrow. Providing the SMSF along with other related parties do not have control, then the value of the units or shares will not be included in the fund’s in-house assets.
- Whether the unit trust or company does not have borrowings and meets the requirements of SIS Regulation 13.22C. If the requirement is met, this will exclude the investment from being included in the fund’s in-house assets. To qualify, the following rules must be complied with at all times, or the investment will be treated as an in-house asset and included in the value of the SMSF’s in-house assets. The result could be the fund breaching the 5 per cent test and required to sell some of its units or shares. It is important that compliance with these rules is carefully monitored. The unit trust or company:
- must not have investments in another entity;
- must limit what it leases to related parties to business property;
- must not have a charge over its assets, such as a mortgage or caveat; and
- not make a loan to another entity with the exception of a deposit with an authorised deposit-taking institution, such as a bank.
- Whether the units or shares can be acquired by the superannuation fund from a related party. As a general rule it is not possible for an SMSF to acquire assets from a related party. However, there are a number of exceptions which include in-house assets on the condition that the SMSF rules will not be breached after the acquisition has taken place.
In addition to the structure in which the development will take place, finance arrangements and control of the unit trust or company is another aspect as to whether the income and capital distributions received by the SMSF are on an arm’s length commercial basis. If the amounts received by the SMSF do not meet an arm’s length commercial rate of return, or expenses are not on an arm’s length basis, the income from the investment fund may be taxed at penalty rates of 45 per cent.
An SMSF is at liberty to invest in a unit trust or company to obtain the benefits of developing a property. But care needs to be exercised depending on whether related parties control the trust or company; whether it is geared or ungeared; or whether the SMSF and other related parties control the company. In view of the complexity of the different aspects of these arrangements, it is always necessary to see whether an SMSF will comply with the SIS Act and Regulations as well as whether the structure chosen will suit the property development. Therefore, the right thing to do is seek professional advice.
So there are some simple rules to follow if a decision is made for an SMSF to purchase a property for development either directly or via an interposed unit trust or company. It is important to make sure the SMSF is aware of the implications of purchasing a property investment and to stay within the superannuation rules throughout the development of the property.
Our next article in this series will cover what the auditor of the SMSF will be looking for with property developments.
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