Peter Johnson, director of Advisers Digest, gave an example of an SMSF that owns a parcel of farming land, with a residential dwelling on less than one hectare.
The hectare includes a machinery shed and a storage shed, while the rest of the property is rented to an unrelated party that runs a farming business. The lease agreement is $15,000 per annum.
The residential portion of the property is rented to a related party of the SMSF and the fund also pays 50 per cent of the electricity account each quarter due to the machinery shed and storage shed around the dwelling.
“The question is how to determine the predominant use of the property. Do you look at the acreage or the income?” Johnson asked.
“We know the people living in the house are a related party, and they’ve got a lease. The farm is subject to a lease to a related party, therefore, prima facie, Section 71 says that it is an in-house asset.”
An exemption is where it is a lease for business real property.
“Section 66 deals with business real property and states it is property used wholly or exclusively in one or more businesses. In this example, it isn’t business real property under the definition, because it’s not wholly and exclusively used in that farming business.”
“But there is a safe harbour for primary production property, and the primary production property is where any residential use of the property is limited to two hectares. The predominant use of the property is primary production.”
He continued that both parts of the property are generating $15,000 in income, but the SMSF also has to pay for the electricity.
“You have to look at the value of the rent, and the value of the primary production. Let’s say you have a five-acre vineyard in the Hunter Valley, and you have two of the five acres being a multi-million dollar mansion, and three acres of vineyards that generate $20,000 a year. The rent of the house would be $100,000, so you go by the value of the rent because it’s just an investment to the super fund.”
“If the super fund is renting half to in-laws and half to the farmers, it is important to determine the predominant use of the real estate.”
In the example, Johnson said he doesn’t believe there is a dominant use of the property as primary production, but if the fund increases the rent by as little as $100 to the farmers it would then have a predominant use being primary production.
“Secondly, how do you justify half the electricity? We’ve got people in the house running air-conditioning, hot water, and people in the shed and if you are paying too much electricity, you have a section 65 breach, because you are now providing financial support to the tenants by paying half their electricity.”
In SMSFR 2009/1, the ATO appears mentions the “acreage” approach (para 223), without raising the income approach. I suspect the ATO would apply both – it would be good for them to clarify this in the ruling.