Residential property: business real property and active asset?
Transferring a residential investment property from a member to their SMSF can sometimes offer significant tax concessions
Business real property for superannuation purposes
For superannuation purposes, trustees are generally prohibited from acquiring assets, including property, from a related party. One exception to this related party acquisition rule is if the asset is business real property (BRP) acquired at market value.
The definition of BRP for superannuation purposes includes any freehold or leasehold interest in real property where the property is used wholly and exclusively in one or more businesses. Therefore, for a property to be a BRP it must satisfy a business use test.
Is a business being carried on?
Whether an entity is using a property in the course carrying on a business depends on the particular circumstances of each case. In Tax Ruling TR 97/11 the Australian Taxation Office (ATO) outlines the factors that are relevant when determining whether a business is being carried on. These include:
• the size and scale and nature of the activity being carried on
• the repetition and regularity of the activities carried on.
In SMSF Ruling SMSFR 2009/1 the ATO provided an example of a situation where a taxpayer owned 20 residential apartments which they leased out and managed themselves. In this case, the ATO confirmed that the properties qualified as BRP as the size, scale and repetition of the activities indicated they were being used in a property leasing business.
Wholly and exclusively
Under the BRP definition a property must also be used wholly and exclusively in the course of running a business. Therefore, any use of a property for private or domestic purposes would generally disqualify the property from being BRP. For example, where the owner of a retail shop also lived on the premises, the property would generally fail the BRP definition.
However, the ATO has confirmed in SMSFR 2009/1 that any private or domestic use of a property will not cause the property to fail the BRP definition where that private or domestic use is:
• occasioned by the business being carried on
• incidental and relevant to the business being carried on
• only minor or trifling.
For example, the use of a motel room by a guest for their private purposes would not disqualify a motel from being BRP as that private use is incidental and relevant to the underlying motel business being carried on.
Property as an active asset for CGT purposes
Real property may also qualify as an active asset under the small business CGT concessions where it is used in the course of carrying on a business by the taxpayer, their affiliate or a connected entity and its main use is not to derive rent (unless only temporarily).
When does a property derive rent?
The ATO has confirmed that income generated from a property will be rent where the property is leased under a landlord/tenant arrangement and the tenant has exclusive possession of the property.
In contrast, the ATO also confirmed that income derived from a property where guests only have a right of occupancy subject to certain conditions will not be rent as the arrangement does not constitute a landlord/tenant relationship. Other factors which would indicate that an amount of income is not rent include:
• where the owner retains a high degree of control over the property
• if the amount charged includes the provision of other services, such as the supply of linen, meals and room cleaning
• where guests have shared rather than exclusive use of the property, including common areas and features such as lounge areas, pools, tennis courts and gardens.
Therefore, a property used in a business of providing accommodation, such as a hotel, motel or resort, could potentially qualify both as a BRP and as an active asset.
In this case, the property could be transferred to an SMSF from a related party and the small business CGT concessions could be applied (subject to satisfying the other eligibility criteria) to reduce or eliminate any resulting realised capital gains.
What about leasing out a single holiday house?
Leasing out a single property, such as a beach house, is generally considered to be a passive investment activity and not carrying on a business. Therefore, a single beach house would generally not qualify as BRP.
In addition, where the lease arrangement entitled the tenant to exclusive possession during the period of their stay the property would be unlikely to qualify as an active asset as its main use would be to derive rent.
Craig Day, Colonial First State, FirstTech