As many can attest, running self-managed super can be complex, but the potential trade-offs make it worthwhile. Commercial property is a popular method of SMSF investment, with Aussies holding more than $105 billion of it in their self-managed super. And that's not including those held via SMSF loans and in trusts.
Whether you're investing in commercial property via an SMSF loan, buying it outright, an in-specie transfer or through a unit trust or tenants in common, there's a few things you should know first.
Basic tenets of SMSF compliance
Business use test: The commercial property must be used wholly or exclusively for one or more businesses i.e. not for private or residential use. Farms are OK provided a dwelling does not take up more than 2 hectares and its main use is not residential.
At arm's length test: Any investments must generally be done 'at arm's length' - this means they must be made at the retail level and away from related parties such as family members. If your business or commercial property is in your SMSF, family-related tenants or employing your child might raise the ATO's attention.
Sole purpose test: The sole purpose must be to provide benefit for SMSF members in retirement. You can't plonk a commercial property in your SMSF for 'present benefit'. You likely must also update your investment strategy and trust deed to allow for commercial property.
Renting the property to your own business
Whether it's a farm or a hairdressing salon, holding commercial property through your own SMSF can be a useful way to support your business. It's possible to pay yourself rent i.e. superannuation contributions provided it's done at market rates.
This can be a useful way to support your own business while eliminating the need for a property manager and finding good tenants.
Improvement and renovation restrictions
You are generally excluded in making improvements or renovations to the property, with few exceptions as listed below.
If you purchased the property outright you may be able to use cash in the fund to make improvements. There are generally restrictions with borrowed money, however.
One area of trouble you may run into is the justification for using those funds to make improvements - do they provide retirement benefits to members?
These are generally different from necessary repairs to ensure the ongoing function of the property.
Penalties for non-compliance
Ensuring your fund stays compliant in the eyes of the ATO can be tough. Here are some areas that could be relevant with commercial property investments.
These three attract up to 60 penalty units apiece, with the current value of one penalty unit being $330.
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Related party loans: You generally can't provide a loan through your SMSF to a related party such as yourself or a family member. Employing related parties in your business' commercial property held in the fund must be done at market rates.
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In-house assets: In-house assets can't exceed 5% of the fund's assets. You may run into this issue if you invest in a related-party asset or certain scenarios with non-geared trust or tenants in common arrangement with your fund.
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Borrowings: You can generally only borrow through an LRBA which sets up a separate bare trust that holds the asset. You must update the trust deed and investment strategy to account for repayments.
Serious breaches could see a notice of non-compliance being issued, which could see the maximum marginal tax rate applied to your SMSF, which is 45%. You could also be disqualified as a trustee in serious contraventions.
Ways to invest in commercial property in SMSFs
There's a few ways to put commercial property in your self-managed super fund. Here's a rundown of the five, and some basic compliance tidbits to keep in mind.
SMSF loan or LRBA
If you don't yet hold the property and don't have the cash, SMSF loans (otherwise known as limited-recourse borrowing arrangements or LRBAs) can be a useful way to leverage yourself.
The security i.e. the property is held in a separate bare trust that limits recourse for the lender in case you default.
Interest rates can be higher, and so can fees, as the lender's risk and compliance regulations are more burdensome. Further, you'll be paying a mortgage so you will need to satisfy cashflow requirements and make sure you satisfy the requirement of providing retirement benefits to members via having the loan.
In-specie transfer
In-specie transfer is an option if you already own commercial property outside your SMSF. With this option, you must comply with the superannuation contribution cap, as well as taxation concerns around capital gains. The property can't be encumbered i.e. has a mortgage.
If it's used for your own business you must be paying market rates, and the SMSF must now pay for the upkeep and expenses on the property.
Buy it outright
Arguably the simplest method - if you have enough cash within the SMSF, you can purchase a commercial property. You must update your investment strategy and trust deed to allow for the purchase, and to justify why investing in one property is better than holding cash.
The simplest way is purchasing via an unrelated third party; you can purchase a property you currently own but you must satisfy business use conditions.
Unit trust
You can set up a unit trust which is co-owned by yourself or related parties and your SMSF. Your SMSF can invest cash into the trust, which is then used as an equity stake in the property.
This can be a useful way to split investments multiple ways so 100% of the property exposure is not sitting within your SMSF. It's also a way to avoid the 5% cap on related-party assets held within your SMSF. It may also be possible to make improvements to the property with this setup.
However there are generally restrictions on how the property is used as well as other compliance minefields such as not being able to gear the property. You may wish to speak to a financial adviser here.
Tenants in common
Similar to the above, a tenants in common structure allows you to co-own the property with your SMSF. All income and expenses need to be proportionately split.
It can be a useful way to avoid the 5% in-house asset rule provided a lease is not provided to a related party. It also makes it simpler to take out a loan but the loan can only be used to fund the SMSF's proportionate stake in the property.
You may, however, run into tax law restrictions that could see you and your fellow tenant in common i.e. the SMSF become related parties, potentially breaching the in-house asset rule.
It's important you speak to a financial adviser or SMSF expert before embarking on your commercial property investment journey.
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