Property developments involving investment from an SMSF are frequently on the ATO’s radar. So is it a permitted investment strategy for an SMSF? The answer, like a lot of things regarding SMSF property investing, is that it’s complicated.
Many clients ask us about investing in property through their self-managed super fund. Whether they’re interested in buying residential property through an SMSF or acquiring commercial property through a SMSF , our answer is always the same. That it’s a popular and rewarding strategy, but trustees need to be careful about the rules around investing their retirement savings into property. And when it comes to investing into property development projects through an SMSF, there’s even more care required.
Update the Investment Strategy to Allow Your SMSF to Buy Land and Build
Property development is a risky business involving unexpected cost overruns, delays and various market forces. It must be in the interest of all members of the fund to embark on this strategy, which will need to be updated to allow for this type of investment. This includes reviewing the risk profile.
Not Just Another SMSF Investment - The Problem With Property Developments
Every SMSF must meet the ‘sole purpose test’ to be eligible for superannuation tax concessions. The rules clearly state that SMSFs must be run for the sole purpose of providing retirement income. Investing in a property development is a commercial activity that can provide a present-day benefit, which instantly puts the strategy on shaky ground.
If you’re the developer and the ATO deems that you’re carrying on a business, the strategy becomes untenable.
However, if you’re outsourcing the project development and using capital in your SMSF to fund it, you can proceed with caution. Make sure you’re not ‘running a business’ and that the property developers are unrelated parties. If the income generated from the investment is deemed non arm's-length income, it will be taxed at the highest marginal rate of 45% compared to the 15% concessional super rate.
When reviewing the carrying on of a business in an SMSF, the ATO looks at whether:
- The trustee employs a family member (things such as the stated rationale for employing the family member and the salary or wages paid)
- The business carried on by the fund has links to associated trading entities
- There are indications the fund's business assets are available for the private use and benefit of the trustee or related parties.
Making Payments to SMSF Members or Related Parties
If you’re hellbent on developing or building your own property, paid for by your SMSF, there are ways. Say an SMSF trustee is also the builder, they can be paid for their services as a builder, provided they’re qualified and in the business of property development. Importantly, the trustee must be paid market rates. If they’re paid above market rates this would likely be a breach of Section 65 of the SIS Act, which prohibits an SMSF from providing financial assistance to members or their relatives.
On the other hand, payments made to trustees that are below market rates could be considered as a ‘contribution’ to the SMSF. In superannuation, a contribution is anything of value that increases the capital of a superannuation fund provided by a person whose purpose is to benefit one or more particular members of the fund.
So when services are provided below market value, it can increase the capital of the SMSF and is considered a contribution. The ATO says that where a related party improves an SMSF asset at no cost to the SMSF this also constitutes a contribution to the sum of the increase in market value of the fund’s assets. With strict caps on contributions, this may cause a fund member to be in breach of cap rules and attract a higher rate of contributions tax.
What Structures Can an SMSF Use for Investing in Property Developments?
Still reading and still think the seemingly simple idea of an SMSF building on vacant land is right for you? Here’s some tips on how to structure things.
- The simplest way is to employ an unrelated property developer to complete the project. You’ll avoid all the related party issues. This can be done through a joint venture where the SMSF buys the land and enters a JV with a builder to do the construction or improvements.
- Another way is for the SMSF to undertake the development by itself. The SMSF acquires a property and uses its funds to make improvements. Note that you can’t use borrowings to make improvements, so the fund must have enough free capital to pay for the purchase and development.
- There are other options that include the use of related & unrelated unit trusts. This becomes increasingly complex, but if you’d like to learn more about non-geared unit trusts, unrelated unit trusts and other strategies, download our free guide to acquiring property in an SMSF .
So, Can an SMSF Invest in Property Development?
Where there’s a will there’s a way. You can enter into property development using your SMSF, but there are many issues at play so it must be done with care. We can’t stress enough that before you embark on the strategies discussed in this article, you should engage a skilled accountant , expert SMSF advisor and a financial planner as to which is the best structure and strategy for you. There are many pro’s and con’s and what is best for one fund may not be for another, which makes tailored advice essential.
