Retiring into a property owned by your SMSF is an appealing idea, but capital gains tax and stamp duty could pose a problem.
The final stage of the SMSF evolution in Australia is the move into retirement by trustees. For some, the dream is to retire into their investment property bought and being paid off by their SMSF. Others may want to sell the fund’s investment property and perhaps buy an annuity.
No matter what the members’ intentions in respect of the fund’s property, they must devise strategies for extricating the property from the holding trust which holds it on behalf of the SMSF and for then transferring it either to the member or a third-party buyer as revenue-efficiently as possible.
That’s the plan, and the actions required to make it happen seem straightforward. So what can go wrong? Not much if you’re careful. And when do you need to be careful? Yesterday.
In fact, you need to exercise care to ensure that the exit from a limited recourse loan arrangement (LRBA) will be capital gains tax (CGT) and stamp duty neutral even before the fund has purchased the property.
For the transfer to the SMSF by the holding trustee to be exempt from stamp duty it is necessary for the fund to use the ‘apparent purchaser’ exemption from duty that most states allow. Queenslanders don’t even need that following recent changes to their Duties Act which exempts from duty any transfer from custodian to SMSF trustees.
To use the ‘apparent purchaser’ rules, all – repeat, all – the money for the purchase comes from the fund and/or the lender to the fund.
And it’s not enough for it to have occurred; to get the duty exemption you need to prove that it occurred. So don’t wait for 10 years to put together the necessary bank statements as evidence of the source of the funds – those statements won’t be available then. Do it straight after settlement of the purchase.
Remember that if the loan is repaid, the holding trust becomes a related trust and an in-house asset and is not eligible for the exemption under s.71(8) of the SIS Act. So unless you can meet the in-house assets test in respect of the holding trust, once the loan is repaid the property must be transferred to the fund. If it doesn’t allow this why not refinance the last, say, $5,000 of the loan with a new loan which does.
To guard against the extremely unlikely possibility that your state government removes the apparent purchaser exemption for duty you could ensure that the loan agreement allows the fund to leave a small amount of the loan unpaid indefinitely so that the property does not have to ever be transferred to the fund.
There will be no CGT payable on the transfer from the holding trustee to the SMSF trustee provided the holding trust established for the LRBA meets the requirements of s.106.50.
These provisions require that the fund be ‘absolutely entitled’ to the property as against the holding trustee. The Australian Taxation Office says ‘absolute entitlement’ effectively means the ability of a beneficiary who has a vested and indefeasible interest in the trust property to call for the asset to be transferred to them or at their direction (TR2004/D25).
Be careful with banks who want the holding trustee to promise not to transfer the property to the fund until the loan has been repaid or the bank consents.
That restriction on the holding trustee’s power to transfer the property could mean that the fund is no longer ‘absolutely entitled’ and that CGT will eventually be payable on the transfer from holding trustee to fund trustee.
If the holding trustee sells directly to a third party buyer on market then provided the SMSF is ‘absolutely entitled’ the CGT will sheet home to the fund. The fund’s CGT rate is lower than the normal rate.
Otherwise, the CGT will be payable by the holding trustee – big problem as the holding trustee’s CGT rate is the maximum.
There’s an old saying in business: start planning your exit on the day the business opens. For SMSFs, the day to start planning how they will eventually liquidate the real estate they buy with their limited recourse loan is even earlier than that – it’s the day they first think about buying a property.
Peter Townsend is a business lawyer and the principal of Townsends Business & Corporate Lawyers
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