Structuring Property Improvements in a SMSF

Relevant For:

SMSF trustees and property investors

Key Points:

• Funding Limitations: SMSFs can borrow to acquire, but not improve assets.
• Partnering Options: Co-investing with others can provide needed funds, but requires compliance with tax and super rules.
• Arm’s-Length Requirement: Ensure all transactions are structured as if between unrelated parties to maintain compliance.
• Tax Risks: Incorrectly structured investments can trigger higher tax rates.
• In-House Assets: Investments in related parties must not exceed 5% of fund assets.
• Unincorporated Joint Ventures: Avoid unnecessary stamp duty by maintaining land ownership in the SMSF while others fund and develop the project.

Full Article:

When a self-managed superannuation fund (SMSF) invests in real estate, the process might seem straightforward due to specific super rules and ATO guidance ensuring tax compliance. However, complexities arise when the land owned by the fund is primed for development or commercial property needs significant upgrades.

Navigating Funding and Compliance for Property Improvements

The rules permitting funds to borrow for asset acquisition do not extend to improving existing assets. This limitation complicates funding and compliance for any enhancement activities. Here’s a practical approach to managing these challenges:

Introducing Other Investors and Maintaining Arm’s-Length Transactions

1. Funding Challenges: If the SMSF lacks the financial resources for the project, partnering with other investors can be a prudent solution. However, co-ownership or profit-sharing arrangements must navigate numerous tax and superannuation rules to ensure compliance.
2. Arm’s-Length Transactions: Structuring these investments on an arm’s-length basis is crucial. This ensures transactions are as favourable as they would be between unrelated parties. When members have business or family ties with co-investors, it becomes vital to maintain these arm’s-length principles to avoid breaches of compliance rules, such as providing financial assistance or failing the sole purpose test.

Tax Implications of Non-Compliance

3. Tax Rates: Incorrectly structured arrangements that favour the fund risk triggering tax integrity rules, potentially taxing all investment income at the highest marginal rate instead of the concessional or tax-free rates.

In-House Asset Rules and Investment Structures

4. Investment Compliance: The structure chosen for co-participation impacts compliance. Investments in incorporated joint ventures or unit trusts may be classified as “in-house assets” if the SMSF acquires control or a majority stake, often leading to breaches if in-house assets exceed 5% of the fund’s total assets.
5. Exemptions and Flexibility: Investments with unrelated parties offer more flexibility, allowing borrowing and securing assets without breaching compliance rules.

Avoiding Unnecessary Stamp Duty with Unincorporated Joint Ventures

6. Stamp Duty Savings: Restructuring land to a company or trust can incur unnecessary stamp duty. An unincorporated joint venture often avoids this, maintaining the land in the SMSF while other parties handle funding and project development.

Conclusion

Improving land owned by an SMSF requires careful structuring to avoid compliance issues, including non-arm’s-length arrangements, financial accommodation breaches, in-house asset limitations, borrowing prohibitions, sole purpose test violations, and unnecessary stamp duty. Specialist advice in income tax and superannuation compliance is essential to achieve the fund’s objectives in a compliant manner.