SMSFs warned on traps with property co-ownership
While acquiring part of a property rather than the whole asset can have advantages for SMSF clients, there are some important compliance aspects to consider, says an industry lawyer.
Townsends Business and Corporate Lawyers solicitor Elizabeth Wang said clients who are thinking about acquiring part of an interest in a residential property which will be co-owned with another SMSF need to think carefully about the provisions in the purchase contract, how the co-ownership will operate and whether there are any compliance issues for their fund.
In terms of the contract of sale, Ms Wang said it should contain provisions which stipulate that after settlement, the property will be held by the two SMSFs as tenants in common as opposed to joint tenants so that the property does not pass to the other owners automatically upon death.
Where a property is co-owned, she said, there can be issues that arise in relation to decision-making and day-to-day management of the property.
“That is why a formal agreement between the two SMSF owners is necessary. Without such an agreement, there is no certainty as to the apportionment of expenses and income, insurance for the property and the first right of refusal in the event that a party wishes to sell their interest,” she explained in an online article.
“Such an agreement not only facilitates administration of the investment but also assists any necessary compliance with s109 of the SIS Act, [which relates] to transactions involving related parties.”
Ms Wang said it is also important that the mortgage over the client’s half interest in the property is completely separate and distinct from any other mortgage which may be granted over the remainder of the property so that neither owner is providing security for the other.
This ensures that if the other SMSF owning the property defaults, the mortgagee will only have access to the portion of the property which secures the loan to the defaulting party and not to any other interest in the property.
“This will make obtaining finance more difficult but not impossible. It must be discussed with prospective lenders early in the application process,” she noted.
While the property half-owned by each fund would not be an in-house asset of either fund, it would not be permissible for either fund to lease the asset to a related party of either.
“If the two SMSFs decided to invest indirectly by buying units in a trust that owned the real estate, that trust could be an in-house asset of any SMSF which effectively controlled the trust,” she explained.
“The fact that the two SMSFs are themselves related could mean that the trust is controlled by the entire group of related parties, which could mean that direct investment in the real estate would be preferable to investment indirectly via a trust, which could be a ‘related trust’ and therefore an in-house asset.”
Miranda Brownlee is the deputy editor of SMSF Adviser, which is the leading source of news, strategy and educational content for professionals working in the SMSF sector.
Since joining the team in 2014, Miranda has been responsible for breaking some of the biggest superannuation stories in Australia, and has reported extensively on technical strategy and legislative updates. Miranda has also directed SMSF Adviser's print publication for several years.
Miranda also has broad business and financial services reporting experience, having written for titles including Investor Daily, ifa and Accountants Daily.