Owning business premises in a SMSF can make a great deal of sense for SMSF’s and business owners alike. It can provide a steady source of income and capital growth for the SMSF and also provides stability for the business owner rather than having a 3rd party landlord. At the same time, having your business premises in a SMSF rather than holding it personally or in a company can offer significant tax savings on disposal. Finally, SMSF’s also offer one of the most robust structures to protect assets from creditors in bankruptcy.
How can the SMSF legally purchase business premises from the business owners?
Unlike residential properties, ‘business real property’ can be purchased from related parties by a SMSF without breaching section 66 of the SIS Act. The property is required to be business real property that is used exclusively in a business (e.g. it can’t be a retail shop with a residential premise above it). In addition, the acquisition needs to be at market value (i.e. independently valued).
The sole purpose of the transaction must be to provide a retirement benefit for the members (i.e. consistent with the investment strategy of the SMSF). You should consult with your financial advisor if appropriate to ensure it is a good fit with your portfolio.
Can the property be transferred for nil consideration?
Business premises can also be transferred into an SMSF without cash (in-specie). The transfer is considered a contribution for the SMSF members and subject to the contribution cap limits. Non-Concessional Personal Contributions of $150k per annum is the contributions limit each year (subject to the age and work status of the member). However, for those members under the age of 65 non-concessional contributions of $450k per member can be utilized using the ‘bring-forward’ rule. Concessional employer or concessional personal contributions can be made of $50k for those over 50 years of age, or $25k for those under 50.
Most SMSF’s have commonly two members (with a maximum of four members), and therefore most small businesses commercial properties being under 1 million dollars in value can typically be transferred in without breaching contribution limits and incurring excess contributions tax. Care needs to be taken when making contributions in the following two years if you trigger the ‘bring forward’ provisions. A combination of cash/in-specie payments could also be done to transfer the property in.
What about gearing if the SMSF does not have sufficient funds to purchase outright?
Yes, this is possible but it is vital that the transaction is completed in the correct manner and properly documented.
Business real property can be purchased by the SMSF from a related party providing any existing mortgage has first been discharged. The existing gearing must be extinguished before being transferred into the SMSF, and a new gearing arrangement can be established through a limited recourse borrowing arrangement. It is critical that an independent valuation is used to determine the purchase price.
Unlike an ordinary borrowing arrangement, a limited recourse loan is established through a bare trust to gear the property legally in an SMSF. It is generally recommended that the level of borrowing does not exceed 60% of the value of the property. The reason for this is that generally the investment will be cash flow positive and not require additional funding from outside the SMSF. Defaulting on repayments in these arrangements may trigger a personal guarantee payment demanded by your bank, and that payment would be considered a contribution by the member, potentially giving rise to excess contribution tax if the contribution limits are exceeded.
The limited recourse borrowing arrangement can be an ideal opportunity to give the SMSF members the ability to purchase a property they would not otherwise have the resources to afford. It is critical to seek expert tax and legal guidance to benefit from these structures.
Commercial Lease Arrangements
Once the property is within the SMSF, a legally enforceable lease arrangement between the trustee of the SMSF and the related party (sec 71 SIS) must be drawn up. We would recommend a solicitor to be engaged to draw up a commercial, fully documented, lease agreement between the SMSF trustees and the business. Rent should be specified in the contract to be payable at a market value from the business to the SMSF and also, for example, outlining the consequences of not paying rent on time. Rent should also be adjusted regularly in future years to ensure that rent paid is always at market value.
Capital Gains Tax
Capital Gains Tax may not be payable on the sale or transfer into the SMSF of an existing property dependant on whether the business premise is used in the related parties business and if they pass the Small Business CGT Concessions. The Capital Gain may also be reduced in certain circumstances by the member making a concessional contribution into the SMSF and claiming a deduction to offset the gain.
Once the members’ of the SMSF turn 55, they can also commence a pension (transition to retirement income stream), and may not be subject to capital gains tax on the subsequent sale of the property. This is a major benefit to business taxpayers that cannot access the small business capital gains tax concessions. Because the tax on the gain is not apportioned between the years the property is increasing in value whilst they are in accumulation phase and the years in pension phase, once a pension has commenced the capital gains on sales of assets within the SMSF become tax free.
If the property is disposed of by the SMSF before pension phase has commenced, and the building has been held for longer than 12 months, the tax on any capital gain is still concessionally taxed in the SMSF at only 10%.
Stamp duty may also be payable in some States when the property is transferred to the SMSF and dependant on how the transaction is structured.
Rental income less outgoings are taxed in the SMSF at 15 cents in the dollar. The rental expense in the business if it is a corporate taxpayer receives a tax refund of 30%, saving 15 cents in every dollar of tax paid by the family overall. This saving rises to 30 cents in the dollar once the members commence pension phase.
The property should also be valued in the SMSF each year on a reasonable basis. An annual independent valuation is not required, and normally a curb side valuation by a real estate agent is sufficient. If the SMSF is in pension mode, the property and the SMSF assets need to be valued at market value each year to continue to qualify for the generous taxation concessions for SMSF’s in pension mode. To continue to qualify for these concessions, a market valuation by a formal valuer every three years would be best practice with curbside valuations in between. The value should always be compared to the Council rates notice. If the SMSF is not valued at market value, then the SMSF may not qualify for the pension concessions and all income will be taxed at 15%.
Having the property in a SMSF also forms an excellent barrier for asset protection purposes, removing exposure of the property to creditors and other inherent business risks. However, there are claw back provisions in the Bankruptcy Act for contributions made to defeat creditors.
SMSF’s lead both industry and retail funds because of the investments that only these funds can purchase. Although trustees take on more responsibility, they will continue to be the superannuation structure of choice in the future. Trustees need to seek advice prior to a final decision to pursue the strategy to insure that any pitfalls are identified and can be provisioned.
Written by Travis Allen CPA, Director, Hillyer Riches