SMSFs flagged on differentiating tax deduction opportunities and traps for property

When it comes to real estate, SMSFs can be eligible for tax deductions and other concessions depending on the property type and how it is used.

In a recent AMP technical update, SuperConcepts technical executive manager Graeme Colley said that SMSFs holding property can be used in different ways such as leasing residential property to unrelated third-party tenants, commercial property to related and unrelated tenants, run a bed and breakfast; or just hold vacant land for development or resale.

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These different types of property can have certain taxes deductions claimed but the key will be to also make sure it complies with the requirements of the Superannuation Industry (Supervision) Act (SIS Act).

“For residential property owned by an SMSF, such as a free-standing home, terrace or apartment, this will usually be rented on an arm’s length commercial basis,” Mr Colley said.

“The written lease may be for six months, a year or longer period as agreed. The tenant is usually required to pay a bond which is held by a relevant government organisation until the lease is terminated.

“Any expenses relating to the property may be claimed by the SMSF as a tax deduction from the day the property becomes available for lease. In many cases, the trustees of the SMSF may employ a property agent to collect the rent and look after the day-to-day administration of the property.

“Any rent received by the SMSF, less the relevant allowable deductions, is included in the fund’s taxable income. The SMSF may be eligible to claim deductions for rates and taxes, administration costs and maintenance of the property.”

Deductions for residential property can include rates and taxes, body corporate fees and charges, council rates and water and electricity paid by the landlord, but not those paid by the tenant and land tax.

SMSFs also need to take into account the property administration such as insurance and property maintenance costs.

“Don’t forget, SMSFs cannot claim a deduction for travel expenses to inspect the property or for the cost of capital improvements to the rental property at the time they are incurred,” he said.

“Capital improvements include the cost of adding a new room, remodelling a kitchen or bathroom, or adding a pergola which are added to the cost base of the property for capital gains tax purposes. 

“However, the SMSF may be eligible to claim a capital works deduction based on the estimated cost of wear and tear to the property and any qualifying improvements.

“Since 1 July 2017, capital works deductions have been restricted to depreciable new assets and restrictions apply to capital works deductions on depreciating second-hand goods.”

Holiday houses and B&B 

A “holiday house” owned by an SMSF is the same as owning a residential property, but Mr Colley noted it’s more likely to be in an area that attracts holidaymakers.

This means the holiday house will have many expenses in common with a residential property. 

“However, because the property is usually leased on a short-term basis, more servicing and upkeep may be required. Also, the SMSF’s holiday house may include kitchen utensils, bed linen and furniture,” Mr Colley noted.

“A deduction is usually available for replacement of utensils, bed linen, depreciating furniture and more regular cleaning of the property.

“The temptation with an SMSF owning a holiday house is that a fund member, trustee or one of their relatives may wish to use the property in the off season. This can be a problem for the fund as the value of the property will be included in the fund’s in-house assets. A 5 per cent limit applies to SMSFs having in-house assets, which is calculated on the total value of the fund’s assets at market value. 

“A breach of the in-house assets test can result in penalties being imposed by the ATO and in some situations could result in the sale of the holiday house.”

For bed and breakfast, Mr Colley said the standard of accommodation differs from place to place, however, the property is usually serviced and re-stocked regularly.

In addition to expenses incurred for a residential property, a bed and breakfast owned by the SMSF may incur expenses such as for consumable, energy costs, or other expenses such as from depreciation on kitchen appliances.

As a result, it will be worthwhile to make sure that receipts or adequate records for any expenses are kept as proof of purchase. 

“Any expenses relating to the bed and breakfast should be paid by the fund where possible,” Mr Colley explained.

“One way of doing this is by providing the fund with its own credit or debit card to make the purchase of items for the bed and breakfast as simple as possible. Sometimes, this may not be possible or practical, and if the trustees pay the expenses personally, reimbursement should be made as quickly as possible.”

Commercial property 

For commercial property, it comes in all shapes and sizes from small shops to factories to parking spaces. Under the SIS Act it is possible for the property to be leased to related parties such as the members, trustees, their relatives or companies or trusts that they control according to Mr Colley.

This means the lease arrangement is required to be properly documented and any rent paid must be determined on an arm’s length basis. 

“Many expenses relating to the commercial property may be the tenant’s responsibility and they may be required to reinstate the property to its pre-leased condition (‘make good’) after it is vacated,” Mr Colley said.

“In some situations, any plant and equipment that is installed in the commercial building may be unique to the tenant’s business and may require a special fit out. The cost of the fit out would usually be incurred by the tenant as part of any lease agreement.

“However, if the tenant is a related party care needs to be taken with the cost of the fit out so that the cost incurred is not treated as a ‘contribution’ on the termination of the lease. The ATO’s taxation ruling TR 2010/1 provides information on whether certain expenses incurred on behalf of the fund could be treated as a contribution if the fit out has resulted in an improvement to the commercial property owned by the SMSF.”