Understanding the complex rules of SMSF direct property investment

Direct property ownership is something that Self-Managed-Super Fund trustees take seriously as part of their investment plans, with this asset class making up about 15 per cent of all SMSF assets.

The split between commercial and residential direct property has been fairly consistent, with about 10 per cent to 11 per cent invested in commercial property and 4 per cent to 5 per cent in residential, according to annual statistics published by the Australian Taxation Office.

SMSFs invest between 10 and 11 per cent in commercial property, according to ATO statistics.Credit:

The advantages of owning direct property include receiving rental income and a lower capital gains tax rate on disposal of the property.

The rental income is taxed at a concessional rate of 15 per cent. Where the property is owned for more than 12 months before sale, then only two-thirds of the resulting capital gain is taxed at the 15 per cent fund tax rate.

There are some specific rules around purchasing, owning and renting property in your SMSF.

Some important issues to remember include:

★  Restrictions on the use by you, your relatives and other related parties of residential property owned by your SMSF, whether you pay rent for using the property or not;

★  Lack of diversification due to the large proportion of the SMSF cash that may be needed to acquire a single property;

★  Dealing with unforeseen events, such as early death of a member or divorce, requiring the forced sale of the property at an inappropriate time;

★  Where borrowed money is used to acquire the property, restrictions on the manner and type of modifications that can be made while the borrowing remains in place;

★ It is not possible for an SMSF to acquire residential property from any related party to the fund, such as members or their relatives. An exception is if the property is commercial – broadly buildings used wholly and exclusively in one or more businesses.

Another aspect not well understood is the way in which SMSFs can own property.

An SMSF can be the sole owner of a direct property or a part owner with another investor. The other investor can be a member or relative of an SMSF member, or an unrelated investor.

Care needs to be taken in relation to the interest acquired by the SMSF and who the property may be rented to, as outlined above.

SMSF specialist expert advice should always be obtained when an SMSF acquires an interest in direct property, given the complex and specific rules that apply.

An SMSF can also own property indirectly by owning units in a unit trust or shares in a company, which in turn own the property.

Equally important as the structure of the SMSF investment in property, is that trustees consider the investment strategy of their SMSF, detailing how much exposure it should have to the property market, the form of exposure and how appropriate it is in the circumstances of the members.

The investments must always be reflected in the strategy set by trustees, so it’s important to understand that this is not a set and forget issue but an ongoing obligation.

John Maroney is chief executive of the SMSF Association

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