Property development through a Self Managed Super Fund (SMSF)

We are often asked by clients are they allowed to undertake property developments through their SMSF.

It is an attractive proposition and can result in handsome returns, but it has to be done with caution and most importantly correctly to comply with the law.

The most important aspect to remember is that any investment by a SMSF has to be done on a ‘arm’s length’ and commercial basis.

Any investment by an SMSF must be managed to reflect true market value of any investment and all prices should reflect this, whether it is a purchase or sale, of any of the property assets, including any returns.

Any personal and business affairs of fund members should be separated from the SMSFs investments and they must always be carried out in accordance with the governing legislation and law.

You must remember that the SMSF is maintained for the sole purpose of providing benefits for the members retirement and/or their death. It is not there to provide present day benefits to any of the members.

There are restrictions which apply to ‘related parties’ and ‘relatives of members’

A ‘related party’ includes:

• all members of your fund
• associates of fund members, which include
  • the relatives of each member
  • the business partners of each member
  • any spouse or child of those business partners
  • any company the member or their associates control or influence
  • any trust the member or their associates control. 
• standard employer–sponsors, which are employers who contribute to your super fund for the benefit of a member, under an arrangement between the employer and a trustee of your fund
• associates of standard employer–sponsors, which include
  • business partners and companies or trusts the employer controls (either alone or with their other associates)
  • companies and trusts that control the employer.

A ‘relative of a member’ means any of the following:

• a parent, grandparent, brother, sister, uncle, aunt, nephew, niece, lineal descendant or adopted child of the member or their spouse
• a spouse of any individual specified above.

An SMSF cannot lend money or provide direct or indirect financial assistance from the fund to a member, or a member’s relative

Any loan made by your SMSF must be in the best interests of members and comply with investment strategy of the fund.

The Australian Taxation Office (ATO) requires that any property development in which an SMSF is involved in must comply with the Superannuation Industry (Supervision) Act 1993 (SIS Act) and be done for proper superannuation purposes.

If the SMSF breaches the tax or superannuation laws any proceeds received from the development can be taxed at penalty rates and result in the fund losing its complying status. Further the trustees could be penalised and is some cases disqualified.

When considering a property development with your SMSF it is important that you turn your mind to the following matters:

• What is the actual property that is to be purchased and then developed?
• What are the roles of the parties who will be involved in the development?
• How is the development going to be financed and what borrowings are they going to be, if any?
• How will the income by distributed and the tax handled on any profits including capital gains tax?
• Does the SMSFs trust deed permit the fund to undertake property development?
• Is property development envisaged by the investment strategy of the SMSF?
• Are any of the assets been bought from a ‘related party’?
• Parties are receiving a benefit which is to the detriment of the SMSF?

How can the SMSF undertake the property development?

Some of the ways in which a property can be developed by an SMSF are:

• Own the property and have a builder undertake the construction
• Through a partnership or a joint venture
• Investing through a company or unit trust which will undertake the purchase and development of the property
• Financing a developer who will undertake development

Can the SMSF borrow money for the development?

An SMSF can borrow money as long as it satisfies these conditions:

• Any loan must be a Limited Recourse Borrowing Arrangement (LRBA)
• The money that is borrowed must only be applied to the purchase of the property asset
• The property asset must be held in a separate trust until the loan is paid
• Once the loan is repaid the SMSF has the right to acquire the property asset
• It must make the loan repayments

What happens if the SMSF defaults on the loan?

If the SMSF defaults on the loan, a financier can only claim against the asset that is being used as security for the loan. It is important that any payments to the SMSF by loan guarantors are clearly classified as member contributions and not loan repayments, so they are protected in the event of a default.

Conclusion

Although property development through an SMSF is allowed the trustees must thoroughly understand the legislation and rules. Developing property using an SMSF is not the same as doing the development yourself. If you get it wrong your SMSF could end up with compliance and tax issues.

It is important to keep accurate records as the ATO and auditors will require this. In particular the trust deed and the investment strategy will often be scrutinised by auditors and the ATO.

Development using an SMSF is complicated and it is important to get the right advice through your lawyers, accountants and financial advisors.

How can we help?

FC Lawyers has a dedicated team of experienced business, commercial and property lawyers who can assist you with all the relevant documentation and compliance issues.

Our team is also used to working with clients trusted advisors including your accountants to ensure a successful outcome for any property development through your SMSF.

If you need any legal assistance with the above, our team of lawyers can assist you. Contact our team today.