A recent AAT decision further illuminates when residential property can fall within the definition of business real property.
Many would say that the trustee of an SMSF is prohibited from ever acquiring residential property from related parties of the SMSF (including members). However, there are two main circumstances when it could happen without contravening superannuation law. Further, the scope for this to occur is actually wider than many think, as illuminated by a recent Administrative Appeals Tribunal (AAT) decision.
Business real property
The focus on whether an asset is business real property stems from the fact that SMSF trustees are prohibited from acquiring any assets from related parties, unless those assets fall within one of the specified exceptions (CommonwealthSuperannuation Industry (Supervision) Act 1993 (‘SISA’) s 66). One of the exceptions is if the asset is business real property. The question is whether residential property can ever fit this definition.
Section 66(5) broadly defines business real property as an interest in real property, where that real property is used wholly and exclusively in one or more businesses (regardless of who carries on that business or those businesses).
There are two ways that residential property can be business real property. The first is where the residential land is held as the trading stock of a land developer. The second is where the residential use is the core of a business of renting out properties. Each scenario is discussed in turn.
Residential land as part of a land developer’s business
It is possible to carry on a business of property development. Indeed, the ATO has recently expressed concern in TA 2014/1 about property development receipts that are business income (ie, ordinary income), but have been declared as capital gains. The question is, what facts need to be present to make this work?
In example 37 of SMSFR 2009/1, the ATO gives the example of a property developer (Trevor) who is in the business of ‘purchasing land for development, obtaining council approvals, hiring contractors, building, selling’. If such a business is on foot, the ATO confirm that one of his properties used in this way qualifies as business real property. What is more, the ATO state that such a property will qualify after the construction and development is complete, while the development is in progress, and even if it is acquired off the plan before any activity occurs on the land. It appears the crux of this reasoning is, if the property is Trevor’s trading stock, it will be business real property.
One factor that can make this scenario more difficult is when the person holding the property has not been declaring business income, but for superannuation law purposes would like to assert they are carrying on a property development business so that the properties can be business real property.
Residential land used in the business of renting properties
To reiterate, business real property is real property used wholly and exclusively in one or more businesses. The word ‘used’ is broad term, and the ATO view is that it is possible for residential use to be inherently in connection with a business. In particular, if there is a genuine business of renting out properties (the ATO call this a ‘property investment business’), the residential use of those properties has a ‘relevant connection’ with the business (see paragraph 191 of SMSFR 2009/1).
The ATO also gives two relevant examples in its ruling. In example 14, Mr Wood owns 20 residential units that are leased to long-term residents. Mr Wood manages the units on a full-time basis and lives on the income generated. The ATO says Mr Wood is carrying on a business, and that his SMSF can acquire one of the units from himself (a related party) at market value. On the other hand, a dampener is given in example 15, where Ms Harrington owns 10 residential units and uses an agent to manage them. The ATO suggest that the use of the agent means Ms Harrington does not carry on a property investment business. A recent AAT decision, however, casts doubt on this reasoning.
In YPFD and Commissioner of Taxation  AATA 9 (‘YPFD’), the taxpayer owned nine rental properties (note that the ATO’s example just above involved 10 units). The AAT found she intended to make profit from leasing them out and regularly repeated activities in order to do so. The properties were partly managed by the taxpayer and partly by agents. The AAT found that reliance on estate agents did not mean there was no business. In fact, Senior Member Ettinger decided that the taxpayer was in fact carrying on a business of renting out properties. This was despite the fact that the taxpayer did not make a profit, was found to have not operated in a business-like or sophisticated manner and did not have a written business plan.
While the AAT is not a court, YPFD demonstrates that 20 properties is not a ‘magic number’, and that having even fewer than 10 properties and using an agent may not negate the existence of a business.
While the above examples give good guidance, individual circumstances can differ greatly. In ascertaining whether a business exists, all the facts need be considered and expert advice should be sought. The ATO agrees the superannuation law meaning of ‘business’ incorporates the general case law meaning (SMSFR 2009/1 ). There is extensive general case law on this topic. Amongst many other factors, established law makes it clear that a business can be small (Thomas v Federal Commissioner of Taxation (1972) 46 ALJR 397). Indeed, it has been held that a person with initially only one goat (and at most five) was in the business of primary production (Commissioner of Taxation v Walker (1985) 79 FLR 161).
Naturally, any residential property that qualifies as business real property must be acquired at market value by the trustee of the SMSF. While technically there is no requirement for the property to be valued by a qualified independent valuer, such a valuation can assist to show how the market value of the property was arrived at.
David Oon, lawyer, DBA Lawyers
SUBSCRIBE TO THE SMSF ADVISER BULLETIN
- 21 Aug 2017Top investment mechanisms for tax savings revealedBy Staff Reporter
- 21 Aug 2017SMSFA appoints high-profile Australian as patronBy Staff Reporter
- 21 Aug 2017Lawyer challenges ATO view on two fund strategiesBy Miranda Brownlee
- 21 Aug 2017Risks flagged with real estate appraisal valuesBy Miranda Brownlee
- 18 Aug 2017ATO locks in details, addresses panic on real-time reportingBy Katarina Taurian
- 18 Aug 2017Data feeds unreliable for new reporting, says mid-tierBy Miranda Brownlee
- view all
- Top investment mechanisms for tax savings revealed
While super remains one of the most tax-effective ways to save for retirement, if you’re unable to stay within caps then it may be worth c...read more
- view all