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Five key considerations when purchasing property in an SMSF

strategy
By Michael Harkin
June 15 2016
4 minute read
Five key considerations when purchasing property in an SMSF
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Make sure you do all the necessary checks before recommending your client to purchase a property in their SMSF, particularly where borrowing is involved.

1. Is it the right investment for the superannuation fund?

The investment strategy of the SMSF needs to be considered in regards to the range of investments available to the trustee. If it is noted that the purchase of a property will cause the range of investments permitted under the investment strategy to be out of alignment, the trustee should meet to consider amending the investment strategy.

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2. Does the fund have the resources to purchase the property outright?

Initial questions that the trustee needs to answer are:

– First, whether the SMSF will purchase the property using available resources of the SMSF;
– Second, whether it is prepared to commit a significant portion of the SMSF assets towards the purchase of a 'lumpy' asset, at the expense of diversification; and
– Third, whether it would be more prudent to purchase a property of a value greater than the available resources, using borrowed funds to complete the purchase.

3. Should the property be purchased in the SMSF or in another entity?

Once the decision has been made in regards to the property to be purchased, the next consideration is the proper structure in which the property will be owned – will the trustee of the SMSF own the property or will, for example, the SMSF own units in a unit trust that will, in turn, own the property?

Unit trusts can provide a number of advantages in comparison to holding the property in the SMSF, such as:

– Providing protection for other assets of the SMSF in the event of accidental injury at the property; or
– Enabling activities that would not be permitted if the property was being purchased by the SMSF/bare trustee under a SMSF borrowing arrangement, eg, significant improvements or development of the property.

4. Will the trustee borrow to acquire the property?

Having decided on the purchase and the structure, it is likely that the decision as to whether the fund will enter into an SMSF limited recourse borrowing arrangement (LRBA) will also have been made. The next decision could be whether the borrowing will be from a bank or other financial institution, or from a related party. Further to that, the amount that would be available for purchase under the borrowing would need to be ascertained.

5. How will the property be managed following the death of a member?

Once the SMSF has purchased an asset, such as property, which forms a significant (‘lumpy’) portion of the assets of the SMSF, consideration needs to be given to what would happen in the event of the death of a member. For example, it may be necessary for the property to be sold or transferred to beneficiaries, if the entitlements of those beneficiaries were required to be paid out of the SMSF. That would most likely occur when adult children or more remote dependents are the beneficiaries.

If the surviving spouse is to be the recipient of the death benefits then the funds, including the ‘lumpy’ assets, could remain in the SMSF and provide a pension to the surviving spouse. That is predicated on the assumption that sufficient income will be generated from the property and other assets to meet the minimum pension requirements, or the higher cost of living requirements, of the spouse.

When the SMSF has borrowing obligations to meet, the situation is compounded.

More considerations

Some subordinate considerations, if entering into an SMSF borrowing arrangement, include:

– Will the fund have sufficient liquidity to meet ongoing loan payments?
– Does the property to be purchased comprise multiple titles?
– Is there a plan to develop or significantly improve the property?
– Does the contract to purchase include the purchase of ancillary items, eg, furniture in an apartment or machinery in a factory?
– Will the appropriate documentation be available prior to signing the contract?
– Who will sign the contract as purchaser?
– Who is the vendor?
– Who will occupy the property after settlement?

Liquidity

In the event of the disability of a member, particularly when the expected contributions in respect of that member are committed to meeting loan repayments, the fund can incur significant financial difficulties. Planning for that should take place at the time of purchase.

Multiple titles

Generally, purchases under the SMSF borrowing arrangements must be under a single title to meet the single acquirable asset provisions. Exceptions to that rule include apartments and car parks that cannot be separated, and farms and factories that have major buildings across multiple titles.

Development or improvement

If the proposal is to develop or significantly improve the property, a standard SMSF LRBA is unlikely to suit. Purchase through a unit trust, most likely using related-party lending, may overcome the restriction.

Ancillary items

The single acquirable asset provisions would be breached if the borrowing is used to purchase ancillary assets, such as furniture in an apartment, machinery in a factory or equipment on a farm. Those items should be purchased using SMSF funds, rather than borrowed funds.

Documentation and signing the contract

The trustee of the SMSF should not sign the contract. Preferably, the bare trust documentation should be available prior to entering into the contract, so as to avoid any subsequent repercussions. Rules as to the timing of signing both the bare trust documents and the contract of sale vary across each state or territory.

Vendor

If the vendor is a related party to the members of the SMSF, there are limitations on the assets that may be acquired. In particular, residential property could not be acquired from a related party in most instances.

Tenant

Similarly, if the proposed tenant is a related party to members of the SMSF, the SIS legislation permits such an arrangement so long as the property is business real property and the lease is legally enforceable. If the property is residential property, it must not be leased to a related party.

Michael Harkin, national manager, training and advice, Topdocs