Trustees of SMSFs have many issues to deliberate when considering the purchase of a property as an investment for their SMSF. That includes whether they will utilise the SMSF limited recourse borrowing provisions under the SIS Act, or purchase the property using available funds.
This paper will consider five key considerations:
- Is it the right investment for the superannuation fund?
- Does the fund have the resources to purchase the property outright?
- Should the property be purchased in the SMSF or in another entity?
- Will the trustee borrow to acquire the property? and
- How will be property be managed following the death of a member or members?
Is it the right investment for the superannuation fund?
The investment strategy of the SMSF needs to be considered in regards to the range of investments available to the trustee. If it is noted that the purchase of property will cause the range of investments permitted under the investment strategy to be out of alignment, the trustee should meet to consider amending the investment strategy.
Initial questions which the trustee needs to answer are:
- firstly, whether the SMSF will purchase the property using available resources of the SMSF;
- secondly, whether it is prepared to commit a significant portion of the SMSF assets towards the purchase of a ‘lumpy’ asset, at the expense of diversification; and
- thirdly, whether it would be more prudent to purchase a property of a value greater than the available resources, using borrowed funds to complete the purchase.
Once the decision has been made in regards to the property to be purchased, the next consideration is the proper structure in which the property will be owned – will the trustee of the SMSF own the property or will, for example, the SMSF own units in a unit trust which will, in turn, own the property?
Unit trusts can provide a number of advantages in comparison to holding the property in the SMSF, such as:
- providing protection for other assets of the SMSF in the event of accidental injury at the property; or
- enabling activities which would not be permitted if the property was being purchased by the SMSF/Bare trustee under a limited recourse borrowing arrangement.
SMSF limited recourse borrowing arrangement
Having decided on the purchase and the structure, it is likely that the decision as to whether the fund will enter into a limited recourse borrowing arrangement will also have been made. The next decision could be whether the borrowing will be from a bank or other financial institution, or from a related party. Further to that, the amount which would be available for purchase under the borrowing would need to be ascertained.
Planning for the occurrence of the death of a member
Once the SMSF has purchased an asset, such as property, which forms a significant (‘lumpy’) portion of the assets of the SMSF, consideration needs to be given to what would happen in the event of the death of a member. For example, it may be necessary for the property to be sold or transferred to beneficiaries if the entitlements of those beneficiaries were required to be paid out of the SMSF. That would most likely occur when adult children or more remote dependents are the beneficiaries.
If the surviving spouse is to be the recipient of the death benefits then the funds, including the ‘lumpy’ assets, could remain in the SMSF and provide a pension to the surviving spouse. That is predicated on the assumption that:
- the spouse is able to retain within superannuation the deceased member’s benefits, considering the limits imposed under the transfer balance cap rules; and
- sufficient income will be generated from the property and other assets to at least meet the minimum pension requirements, or the higher cost of living requirements, of the spouse.
When the SMSF has borrowing obligations to meet, the situation is compounded.
Some further considerations for the SMSF trustee, if entering into a limited recourse borrowing arrangement, include:
- will the fund have sufficient liquidity to meet ongoing loan payments?
- does the property to be purchased comprise multiple titles?
- is it planned to develop or significantly improve the property?
- does the contract to purchase include the purchase of ancillary items e.g. furniture in an apartment or machinery in a factory?
- will the appropriate documentation be available prior to signing the contract?
- who will sign the contract as purchaser?
- who is the vendor? and
- who will occupy the property after settlement?
The inability of certain members to contribute to the SMSF, because of age or Total Superannuation Balance limitations, is a very important factor in considering liquidity and cash flow needs.
In the event of the disability of a member, particularly when the expected contributions in respect of that member are committed to meeting loan repayments, the fund can incur significant financial difficulties. Planning for that should take place at about the time of making a decision to purchase property in the SMSF.
Generally, purchases under the SMSF limited recourse borrowing arrangements must be under a single title in order to meet the Single Acquirable Asset provisions. Exceptions to that rule include apartments and car parks which cannot be separated, and farms and factories which have major buildings across multiple titles.
Development or improvement
If the proposal is to develop or significantly improve the property, a standard SMSF limited recourse borrowing arrangement is unlikely to suit. Purchase through a unit trust, most likely using related party lending, may overcome the restriction.
The Single Acquirable Asset provisions would be breached if the borrowing is used to purchase ancillary assets, such as furniture in an apartment, machinery in a factory or equipment on a farm. Those items should be purchased using SMSF funds, rather than borrowed funds.
Documentation and signing the contract
The trustee of the SMSF, when acquiring property under a limited recourse borrowing arrangement, should not sign the contract. Preferably, the Bare Trust documentation should be available prior to entering into the contract, so as to avoid any subsequent repercussions. Rules as to the timing of signing both the Bare Trust documents and the contract of sale vary across each State or Territory.
If the vendor is a related party to the members of the SMSF, there are limitations on the assets which may be acquired.
In particular, residential property could not be acquired from a related party in most instances.
Similarly, if the proposed tenant is a related party to members of the SMSF, the SIS legislation permits such an arrangement so long as the property is Business Real Property and the lease is legally enforceable. If the property is residential property, it must not be leased to a related party.
As can be seen above, purchasing property in an SMSF contains a number of key considerations, and, flowing from those decisions, a further range of considerations, particularly if a SMSF limited recourse borrowing arrangement is intended.
Should you have any queries, or require more information, please contact the team at Topdocs on 1300 659 242.
This article first appeared on Topdocs.
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