Expert SMSF insights
SMSFs and property development – What you need to know
By Graeme Colley
In the past year, regulators and SMSF auditors took a closer look at SMSF investments and investment strategies, especially with funds that have a high concentration of investments in one asset class. The ATO published its concerns for SMSFs that have invested directly and indirectly in real estate development projects. While they consider it possible for SMSFs to undertake the property development or invest in a trust or company that undertakes development, funds may end up walking a very thin line between complying with or breaching the Superannuation Industry (Supervision) Act (SIS Act) and Regulations.
When done correctly, property developments undertaken by an SMSF can be a legitimate investment, but the ATO’s concerns relate to developments which are not solely for genuine superannuation purposes. Examples include SMSFs that throw good money after bad by propping up a poor development, or where the SMSF is used to receive excessive income and capital gains into a low tax environment. Where the SMSF breaches the tax or super laws, any income - including capital gains from the development - may be taxed at 45 per cent. The fund could also lose its complying status and the trustees could be penalised or even disqualified.
What you need to consider
There’s lots to think about with property development. It’s risky business, especially if you are inexperienced or don’t understand the building and development game. You may need support with development applications and dealing with councils, builders or tradies. Then there’s the matter of who will do the development, as well as ownership structures, distribution of profits and dealing with the tax and superannuation legislation.
At SuperConcepts, we understand how superannuation laws impact on the structures used when it comes to property development. As trustee of your SMSF, you’ll need to be careful and make sure your fund continues to be maintained only for superannuation and retirement purposes.
If your SMSF wishes to develop properties, either directly or indirectly, there are a number of questions that you need to consider:
- Does the development compromise the SMSF complying with the SIS Act and provide benefits to other parties which are not solely for superannuation purposes apart from the payment of retirement benefits or benefits to dependants on the member’s death?
- Does the fund’s trust deed or other governing rules permit the fund to undertake property development?
- Will the investment strategy recognise the fund being involved in property development and how it is relevant towards providing superannuation benefits for members and their dependants?
- Will the SMSF continue to meet the record keeping requirements of the SIS Act and Regulations including market valuation of assets and that fund assets are kept separate from member’s personal assets?
- Will the development involve making loans or providing financial assistance to members or their relatives?
- Does the development require the SMSF to borrow for purposes of a limited recourse borrowing arrangement? If so, have the compliance issues been considered as it may result in a breach of the SIS Act.
- Are any of the arrangements considered to be in-house assets? If they are, will the fund exceed its in-house asset level because of the investment, loan or lease at the time it was made or as at 30 June in the financial year?
- Has the SMSF acquired assets from a related party which are not permitted under the SIS Act?
- Are all aspects of the property development being undertaken on an arm’s length commercial basis so that no other parties are receiving a benefit which is to the detriment of the SMSF?
In addition to the requirements of the SIS Act, any income and expenses in relation to the property development must be on an arm’s length commercial basis. If they are not and the income received by the fund is greater than if the development had been on an arm’s length commercial basis it will be taxed at penalty rates. Whether income is excessive includes situations where goods and services supplied for the development are provided at a discount or for no cost.
Some of the ways in which a property can be developed can include your SMSF:
- ·owning the property directly and contracting a builder to undertake construction,
- becoming a partner in partnership or entering into a joint venture with others to undertake the project,
- investing in a company or unit trust which will undertake the purchase and development of the property, and
- lending to a developer who will undertake development of a property via one of the above business structures.
Keep an eye out for our next article, which will explore the various ways an SMSF can become involved in developing property and some of the tips and traps.
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