Natalie Scott, superannuation adviser and trainer for Knowledge Shop, said in a recent webinar for Accurium that many SMSF trustees looking at investing in business real property (BRP) miss the first condition that will ensure that such an investment is compliant.
“A lot of people automatically jump to the second condition, which is ensuring that they meet the business use test but forget the first condition which is whether the SMSF will hold an eligible interest in real property,” Scott said.
“Before we even think about what the property will be used for you have to consider the first condition. For a lot of people that might seem obvious, but in some scenarios there isn’t an eligible interest in real property.”
Scott said if the first condition is met, the fund then needs to look at the business use and whether the property is, or will be, used in a business wholly and exclusively.
“There are thresholds for this and they can be quite high and onerous,” she said.
“The ATO has information in relation to meeting that wholly and exclusively threshold, and when your clients may have a problem if they’re not using the entire asset for business purposes.”
Not only is the definition of BRP important, but it is also essential to know whether a property is a business or a property when purchasing from a related party.
“Any time a fund purchases assets from a related party, Section 66 of the SIS Act applies. This effectively prohibits an SMSF from acquiring assets from a related party,” Scott said.
“However, there are exclusions, and one of those exclusions is business real property, the other is listed securities and certain in-house assets.”
It is also necessary to understand the regulations around leasing an asset to a related party and how that interacts with the BRP definition to determine whether that lease would be considered an in-house asset.
“If you think about assets in the SMSF, you generally cannot lease them to a related party. If you do, then it’s an in-house asset.”
“Again, there’s an exclusion for assets that meet the BRP test. If you lease a property to a related party and it meets the BRP test, it won’t be included as an in-house asset. So again, it’s really important that you understand the definition of BRP because if you get it wrong it would be catastrophic for the fund in that it may mean the fund has to sell that asset, which is never an ideal situation, particularly when a lot of time properties make up the bulk of the fund with assets.”
Furthermore, Scott said, the regulations around ungeared unit trusts and BRP need to be well understood to avoid compliance issues.
“In unit trusts there are quite a few restrictions on what they can and can’t do and just like an SMSF can’t lease residential property to a related party, a unit trust cannot lease residential property to a related party.”
“If you want to lease an asset to a related party it needs to be BRP and the same goes for purchasing assets from related parties in the unit trust. There will be an issue with meeting the exemption if the property doesn’t meet the BRP definition.”
Finally, Scott said regarding BRP, a fund should also consider the regulations around in-specie contributions.
“Effectively, what you are doing is two transactions in one – purchasing that property from the member at market value, and then the member making a contribution with that value of the property.”
“A lot of the time, particularly depending on where you reside, if you’re in one of the capital cities in Australia, then you probably would be doing a mixture of in-specie contributions in that property due to the fact that our non-professional rates are not that high anymore.”
She added it is important to understand that with in-specie contributions trustees still need to consider section 66 when making a contribution.
“If you’ve got a client looking to contribute a property into super and its residential property, it’s probably going to be a no, unless you can meet the BRP definition.”
