Several issues need to be considered when devising an investment strategy for a self-managed super fund (SMSF). One of these issues includes the substantial distinction that can be drawn between an ‘in-house asset’ and a ‘related party investment’.
An ‘in-house asset’ is an asset of the fund that is a loan to, and investment in or lease with, a related party of the fund.
A ‘related party investment’ is also an asset of the fund that is a loan to, an investment in or lease with, a related party of the fund but meets one of the exceptions of the ‘in-house asset’ rules.
While they seem similar, and one is in fact a subset of the other, the distinction is relevant because a fund is not permitted to invest more than 5 per cent of its capital in an ‘in-house asset’ whereas no such cap applies to a ‘related party investment’.
So, when is a ‘related party investment’ not an ‘in-house asset’? (i.e. what are the exceptions to the ‘in-house asset’ rules?)
Some of the most commonly utilised exceptions to the ‘in-house asset’ rules include;
- A life policy issued by a life insurance company, but not a life policy acquired from a member of the fund or a relative of a member.
- An investment in a pooled superannuation trust made on an arm’s length basis.
- Real property subject to a lease, or to a lease arrangement enforceable by legal proceedings, between the trustee of the fund and a related party of the fund, if throughout the term of the lease or lease arrangement, the property is business real property of the fund.
- An investment in a widely held unit trust. A unit trust in which the unit holders have fixed entitlements to all of the income and capital of the trust, and fewer than 20 entities between them do not have fixed entitlements to 75 per cent or more of the income or capital of the trust.
- Property owned by the fund and a related party as tenants–in-common, other than property subject to a lease or lease arrangement between the trustee of the fund and a related party.
In addition, an SMSF is able to invest in a unit trust or a company without that investment being considered an ‘in-house asset’ if certain conditions are met. The main conditions include, but are not limited to the unit trust or company not acquiring an asset from a related party of the fund other than business real property, do not directly or indirectly lease assets to related parties other than business real property and do not conduct a business.
Case study: investment strategies and ‘in-house asset’ restrictions
Mr and Mrs Brown have established an SMSF in which they are the members and trustees. The fund has $70,000 in cash which, as trustees, they would like to use to purchase a one third interest in a residential property in Byron Bay used for holiday letting. As individuals, Mr and Mrs Brown will own the other two thirds interest. They will borrow money to fund their purchase but their private residence will be used as security. Mr and Mrs Brown intend to use the holiday property when it is not being rented. It will, however, be available to rent for the whole year. For the purposes of this example, what are the areas of concern you would have to consider in relation to the ‘in-house asset’ restrictions? The SMSF, and Mr and Mrs Brown as trustees of the SMSF, can invest as tenants-in-common in a residential property as it falls within one of the exceptions of an ‘in-house asset’. The property would need to be bought from an unrelated party. A member, or any related party, would not be permitted to rent or reside in the property otherwise it would constitute an ‘in-house asset’. The ‘in-house asset’ rule is a day-by-day test and any stay by Mr and Mrs Brown or a related party would require the trustee to include the full market value of the property as an ‘in-house asset’ of the fund. If the market value exceeds the 5 per cent rule, then the trustee is in breach of the ‘in-house asset’ rules.
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