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Property in an SMSF - residential as business

Sep 9, 2021, 10:15 AM
By Graeme Colley
Executive Manager SMSF Technical and Private Wealth

Graeme-Colley_90x90mmResidential property may qualify as ‘business’ property.

Residential property owned by a fund member is usually prohibited from being acquired by the member’s SMSF. However, there are exceptions where the acquisition can take place if the property qualifies as business property. This will include situations where the member is carrying on a business of leasing residential properties; the property is used as a serviced apartment or as a bed and breakfast. However, to make sure the member is on the right track, a ruling should be obtained from the ATO where the circumstances are not free from doubt.

The superannuation legislation that prevents investments that are owned by related parties are strict, such as members, trustees or their relatives, but there are exceptions. The exceptions are limited to listed shares, business property, in-house assets and some insurance policies on member’s lives. What constitutes a business property depends on whether the property is used wholly and exclusively in a business. This can extend to a member running a business in the property or where it forms part of a business.

Why is the distinction between use of the property for business purposes or other purposes important? If the property satisfies the business use test, then it can be acquired by the fund from a related party otherwise the acquisition cannot go ahead. Acquisition covers situations where the fund wishes to purchase the property from the related party, or where it is transferred to the fund and the value of the property is treated as a contribution.

There are a number of court and tribunal cases which have considered whether a business is being conducted, including the issue of carrying on a business of leasing. However, the common element in cases that were successful relied on: the number of properties involved, the scale of the operation, how it is organised, as well as the involvement of the owner in managing the arrangement. Where a number of these elements are not present, it is unlikely that a business of leasing can be established. For example, it is unlikely that one or two residential properties would be considered as a leasing business. However, where many properties are owned and managed in a business like way, the operation is more likely to meet the business test.

Example – lease of a residential property to a tenant
A member of an SMSF owns a residential property which is leased to a residential tenant. The use of the property will determine whether the use of the property will qualify as business property. If this was the only property owned personally by the member, it would be treated as being used for non-business purposes and therefore could not be acquired by the SMSF. However, it is possible for a residential property to meet the business test if it formed part of an investment business carried on by its owner.

Example – short-term accommodation
The use of residential accommodation for short-term purposes, such as a boarding house, may qualify as business property because of the way in which the guests use the accommodation, the size of the operation and the businesslike way in which it is organised. The use of an agent or management organisation to conduct the operation does not change the business nature of the use of the residential property.

Example – residential property as part of a property investment business
A person owns 25 residential properties that are leased to long-term tenants, which are managed and maintained by the owner. The owner considers whether he should sell one of the properties to his SMSF.

Given the scale of the operation and the business-like way in which the activities are organised, it would be considered a property investment business is in operation. Any of the properties that form part of the business could be acquired by the individual’s SMSF providing it is at market value.

Bed and Breakfast property – business property or not?

Whether a residential property used as a bed and breakfast operation could be considered as business property would depend on the same rules as any other property. This depends on the scale of the operation, as well as the organisation of the activities in a business-like way.

Bed and breakfast - no business in existence
A person owns a large five bedroom home and during the holiday periods guests stay in two of the bedrooms on a bed and breakfast basis. The remainder of the house is used by the person’s family.  Due to the small scale of the activities and the lack of organisation it is unlikely that are businesslike operation is in place.

Bed and breakfast – business-like operation
A person owns a house which has five bedrooms and a number of separate living areas.  Also, there is a building on the property which has been fitted out as a two-bedroom apartment. The owner uses one of the bedrooms and a living area. The other four bedrooms plus the two-bedroom apartment are advertised widely as being available to let throughout the year and are serviced as bed and breakfast accommodation.
It would be considered a bed and breakfast business is in existence as the non-business use of the property is merely incidental and required for it to operate efficiently.
Accordingly, the property is used wholly and exclusively in the business and therefore qualifies as business real property.

Qualifying as business property

Whether a property qualifies as business property depends on the facts surrounding the use of the property and how it may integrate into a person’s business. Where residential property is involved it is necessary to establish that it qualifies as part of a business operation which relies on its purpose, size and scale.

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