Traps when transferring a business premises into an SMSF
Transferring a business premises to an SMSF definitely has its advantages but understanding the negatives is critical to your client's success.
While the merits of SMSFs holding direct property investment continue to be debated, most agree there are real benefits in business owners holding the property of the business premises as an investment in a SMSF.
Transferring the business premises, referred to as “real business property”, into a SMSF is a good way of extracting funds out of the business, in a tax effective way. It means the business owner is paying rent to the super fund, rather than to some third-party landlord. It is one of the few ways to utilise superannuation investments in the business.
But in the rush to transfer the business property to the SMSF, investment fundamentals should not be forgotten. A key consideration is that holding the property in the SMSF has to make sense from an investment, tax and income perspective, and not simply because property is viewed as the hot asset class of the moment.
If the business premise is the only asset of the superannuation fund, questions should be asked as to whether it is the best option. There are a number of problems in having a large portion of superannuation savings tied up in one asset. Having one dominant asset class brings increased risk to any superannuation portfolio. And having only one asset in that asset class exacerbates it further. Additionally, property is usually illiquid, which may cause issues for the SMSF, particularly if any of the fund members are in pension phase and also need regular income from the fund.
Nevertheless, transferring the business property is a popular option, often for good reason.
What can be transferred?
It is important to understand what constitutes business real property. It can be a factory, or a shop or an office. But it can’t generally be a house, and it is not normally vacant land either.
The use of the property is another key consideration before any SMSF transfer can take place. The property must be used solely for business. This means it cannot be part commercial and part residential. If this is the case, the titles will need to be split. The resulting transfer of property to the SMSF can only be that portion of the property that is on the commercial title.
Importantly, business real property cannot include company title or shares in a company that solely owns the business property. It also does not include the business property’s furniture or non-fixtures.
The tax office definition for business real property is land and buildings used wholly and exclusively in a business.
Once the suitability of the property is established, the transfer can take place. The business property can be transferred in specie, that is, as a contribution in the form of an asset other than money or cash, and be treated as a contribution by the transferor. Alternatively, the fund can acquire the premises by cash, whether it is cash already in the fund, or by borrowing.
While tax office rules say that super funds generally must not intentionally acquire assets from related parties of your fund, business real property is a significant exception to this rule.
The biggest benefit of this strategy is that the business receives a tax deduction for the rent paid to its super fund. The rent received by the SMSF is taxed at the low superannuation rate of 15 per cent (or zero if fund is in pension phase).
Significantly, the rent received by the SMSF is not subject to a cap in the way that superannuation fund contributions are. This provides an additional, tax-effective means of building up retirement savings.
As well, when there are significant assets in the SMSF, there is the advantage that the business is able to use the member’s retirement funds to support the business without having to use debt.
An additional advantage is the possibility that the transferor (be it the business entity or the fund member) can access the small business capital gains tax (CGT) concessions with the transfer of the business premises to the super fund. This may have the effect of reducing or eliminating any CGT liability on the transfer or sale of the business premises to the super fund.
Finally, it may be possible to receive stamp duty concessions on the transfer where, depending on the state or territory, only a nominal duty is imposed on the transfer, for transfers between an individual and a super fund.
The biggest disadvantage of this strategy, however, is that depending on what other assets are available, it can reduce the diversification and liquidity of the fund.
These liquidity issues can be long-ranging and difficult to foresee, and can be triggered by the death of a fund member. For example, if two business partners are in a SMSF that was set up for the express purpose of owning the business property and one of them dies, the business property may have to be sold to pay out death benefits.
There is also the risk of having one’s retirement benefits linked to one’s business. It may be that the business premises may not be the best type of investment to hold in the fund, as commercial properties can have lower rates of growth than residential properties or other asset classes. Also, if the business falls behind in rental payments and the fund takes no action to recover the shortfall, then the fund’s compliance status is at risk because the fund is effectively providing financial assistance to a related party, which is a breach of the SMSF investment rules.
There is no question that property investment can reward SMSF investors with capital growth and steady rental income. The decision whether to transfer the business property into the SMSF is a matter of determining not only the investment merits of the business real property in question, but also the current and future needs of the members of the SMSF.
Andrew Yee, director, superannuation, HLB Mann Judd Sydney.