Direct property is an attractive investment and is what often drives people to set up an SMSF.
Many people opt for residential property. The SMSF rules explicitly stipulate that a residential property cannot be leased to a member, or anyone related to the members of the fund, even at market rate rent. Further to this, individuals cannot contribute/sell a residential investment property they already have to an SMSF.
Commercial property however, is a completely different story. Commercial property can be contributed or sold to an SMSF by its members as well as being leased to SMSF members or an individual or business related to them
This is an attractive proposition for small business owners and professionals who wish to own the premises from which they operate. In fact, many such individuals who own the building they operate from as their ‘retirement savings’, so why not have it in the same tax concessional environment that others have their superannuation? And why pay a landlord when you can utilise your super to purchase a property and effectively pay rent to yourself?
If you already own the commercial property, it can be contributed to the super fund (subject to the contribution caps). This must be done at market value and will have capital gains tax consequences for the individual transferring in the property. There may be stamp duty applicable, depending on which state the property is in. There may be small business retirement exemptions applicable to assist with the capital gains tax and contribution caps.
Any rental income (after deductions) is taxed at 15%, and if the property is held for more than 12 months and then sold, capital gains are taxed at 10%. Once the super fund is in ‘pension phase’, there is no tax payable on the income, and the sale of the property does not incur any capital gains tax. This is providing the value of the property is within the member’s $1.6m balance cap.
If the SMSF is to lease the property to a related party, it must be done on the same terms as it would with an independent third party. A lease arrangement needs to exist with terms and conditions of standard commercial agreements. Rent needs to be paid at market rate and regularly and physically into the SMSF bank account, not just a ‘journal entry’ in the books of the business and the SMSF. The property will also need to be regularly independently valued.
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SMSF’s are also required to value all of its assets at market value. The valuation needs to be based on objective and supportable data. In the case of commercial property, a real estate agent or registered valuer should be engaged to provide an independent valuation.
If the rental income per annum is over $75,000, the fund will also need to register for GST. If the SMSF is registered for GST it can claim 100% of GST on any expenses associated with the commercial property.
Note that it isn’t just small business owners and professionals that can hold commercial property in their SMSF, this investment choice is open to all SMSF trustees.
A super fund may borrow to purchase commercial property via a limited recourse borrowing arrangement. Keep in mind that the borrowing criteria assigned to SMSF’s is much stricter than that imposed on individuals. It appears at present you would need to have at least $200k in super, and LVR are around 70%.
Diversity of investments is something all trustees are asked to consider and document in the fund’s investment strategy. There may be liquidity and flexibility issues if a fund just holds one ‘lumpy asset’ such as property. What if there is a period of time when the property is not leased and the members of the fund are relying on the SMSF to provide them an income stream? Property is not like a parcel of shares where you can sell a portion of it. Or if the property market goes into sharp decline and it’s the only asset held by the fund, the overall value of retirement savings is impacted.
Commercial property continues to make sound sense from a tax planning and long term capital growth perspective for many SMSF Trustees. Where the trustees are also small business owners, there is added benefit, providing all transactions occur on an arm’s length basis. However, the issues such as lack of diversity and liquidity requirements must be considered against these benefits when deciding on whether commercial property is the right investment for your SMSF.
Kimberlee Brown is the SMSF Director at H&R Block.
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