Managing hurdles impacting SMSF residential property transition to business
When considering the transition of residential property and business property in an SMSF for acquisition purposes, there are several distinctions that need to be checked off to ensure it can satisfy the ATO requirements.
Residential property owned by a fund member is usually prohibited from being acquired by the member’s SMSF. However, there are exceptions where the acquisition can take place if the property qualifies as business property.
The ATO states that this will include situations where the member is carrying on a business of leasing residential properties, the property is used as an apartment or as a bed and breakfast. However, to make sure the member is on the right track, a ruling should be obtained from the ATO where the circumstances are not free from doubt.
SuperConcepts technical executive manager Graeme Colley said the superannuation legislation that prevents investments that are owned by related parties are strict, such as members, trustees or their relatives, but there are exceptions.
“The exceptions are limited to listed shares, business property, in-house assets, and some insurance policies on member’s lives,” he said in a technical update.
“What constitutes a business property depends on whether the property is used wholly and exclusively in a business. This can extend to a member running a business in the property or where it forms part of a business.
“Why is the distinction between use of the property for business purposes or other purposes important? If the property satisfies the business use test, then it can be acquired by the fund from a related party; otherwise, the acquisition cannot go ahead.
“Acquisition covers situations where the fund wishes to purchase the property from the related party, or where it is transferred to the fund and the value of the property is treated as a contribution.”
There are a number of court and tribunal cases that have considered whether a business is being conducted, including the issue of carrying on a business of leasing.
However, Mr Colley noted the common element in cases that are successful take into account the number of properties involved, the scale of the operation and how it is organised, as well as the involvement of the owner in managing the arrangement.
Where a number of these elements are not present, it is unlikely that a business of leasing can be established. For example, it is unlikely that one or two residential properties would be considered as a leasing business.
However, where many properties are owned and managed in a businesslike way, the operation is more likely to meet the business test.
For example, where a member of an SMSF owns a residential property that is leased to a residential tenant, the use of the property will determine whether the use of the property will qualify as business property, according to Mr Colley.
If this was the only property owned personally by the member, it would be treated as being used for non-business purposes and, therefore, could not be acquired by the SMSF. However, it is possible for a residential property to meet the business test if it formed part of an investment business carried on by its owner.
“The use of residential accommodation for short-term purposes, such as a boarding house, may qualify as business property because of the way in which the guests use the accommodation, the size of the operation and the businesslike way in which it is organised,” he said.
“The use of an agent or management organisation to conduct the operation does not change the business nature of the use of the residential property.”
In another example, a person owns 25 residential properties that are leased to long-term tenants, which are managed and maintained by the owner. The owner considers whether he should sell one of the properties to his SMSF.
Given the scale of the operation and the businesslike way in which the activities are organised, Mr Colley observed it would be considered a property investment business in operation. Any of the properties that form part of the business could be acquired by the individual’s SMSF, providing it is at market value.
BnB property considerations
Whether a residential property used as a bed and breakfast operation could be considered as business property would depend on the same rules as any other property, according to Mr Colley.
This depends on the scale of the operation, as well as the organisation of the activities in a businesslike way.
“A person owns a large five-bedroom home, and during the holiday periods, guests stay in two of the bedrooms on a bed and breakfast basis. The remainder of the house is used by the person’s family,” he noted.
“Due to the small scale of the activities and the lack of organisation, it is unlikely that a businesslike operation is in place.”
In another example, a person owns a house that has five bedrooms and a number of separate living areas, and there is a building on the property that has been fitted out as a two-bedroom apartment.
The owner uses one of the bedrooms and a living area. The other four bedrooms plus the two-bedroom apartment are advertised widely as being available to let throughout the year and are serviced as bed and breakfast accommodation.
“It would be considered a bed and breakfast business in existence as the non-business use of the property is merely incidental and required for it to operate efficiently,” Mr Colley explained.
“Accordingly, the property is used wholly and exclusively in the business and, therefore, qualifies as business real property.”
Tony Zhang is a journalist at Accountants Daily, which is the leading source of news, strategy and educational content for professionals working in the accounting sector.
Since joining the Momentum Media team in 2020, Tony has written for a range of its publications including Lawyers Weekly, Adviser Innovation, ifa and SMSF Adviser. He has been full-time on Accountants Daily since September 2021.