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Self Managed Super Fund (SMSF) Article
Rules for Buying Property Properly
By Tony Negline.
This article may be out of date.
16th August 2006
SOME people strongly believe that real property is the best way to grow your money.
In truth, many Australians are so blinded by this "truth" they refuse to believe wealth can be created in any other way. Many of these people argue that compared with property, superannuation is not a good investment.
Unfortunately, this argument is not comparing like with like. In simple terms, property is an investment class. Other investment classes are shares, cash and so on. Superannuation is not an investment class.
It is an investment structure that holds a range of investment classes, including property.
Now whether superannuation is the right place to hold particular investments is another matter.
One could say there is quite a lot of risk in investing in superannuation, because the Government is always changing the rules - and how does anyone know if a future batch of amendments won't penalise a particular investor?
After all, no one can predict the future. However, the fact is, this same risk applies to all investment structures and to all investment classes a person could use to build wealth. It is commonly called legislative risk.
But back to the main issue - using a super fund to own property. As with any super investment, there are several important issues to consider.
Just like any other investment structure, there are at least three different ways that a super fund can own property:
* Sole owner.
* Jointly with one or more individuals or one or more entities.
* The super fund might be an investor in another entity - for example, a unit trust or a company that owns a property.
Before investing in property a super fund's trustees should acquaint themselves with specific rules so they can meet all necessary requirements, because a failure to comply with these rules can result in fines and penalties. Here are some of the main rules:
* Restrictions on how parties "related" to a super fund can use a property: the definition of super fund related parties is quite complicated.
They are fund members, a member's relatives, some employers who contribute to a fund and entities that are controlled or are deemed to be controlled by the member or their relatives.
Generally, a super fund's related parties cannot use a property owned by a super fund. But there are two exceptions to this rule.
First, if the fund is a self-managed super fund or is a Small APRA Fund, a related party can use the property if is it used wholly and exclusively in the running of a business.
Second, a related party could use a fund's property if its market value represents less than 5 per cent of the market value of all a super fund's assets.
* If a super fund owns a property with other entities or individuals, then the above rules apply.
For example, suppose a super fund owns 5 per cent of a holiday home and a husband and wife own the remaining 95 per cent. In this situation, the husband and wife cannot use the property as it probably fails both exemptions.
First, it is reasonable to assume that the holiday home will not be business real property. Second, the market value of the property almost certainly will be more than 5 per cent of the total assets of the fund.
Note that it is not the value of the fund's investment in the property that is used for this test, but the value of the assets.
* It is also important that if a super fund owns a property with other entities or individuals, then the fund needs to ensure the property is not used by the other entities as a security for any borrowings.
This situation typically appears when an investor wants to buy a property but doesn't have enough money in their super fund to buy all of it and similarly doesn't have enough personal money to buy it.
Often the investor wants to gear the investment and needs to offer an asset as security, and so decides to offer the property as security. This is not allowed.
* If a super fund invests in another entity, such as a unit trust or company, which owns a property, then the super fund must ensure that the other entity does not have any other investments except a bank account (or other similar investment).
Further, if the entity leases the property to a related party of the super fund, then the property can only be used exclusively in the running of a business.
* A super fund must deal with all parties at arm's length. This means that rents or leases should be based on strict commercial rules and any rental payments not remitted on time must be followed up.
The super fund must be prepared to evict a related party if that is what they would do with a third party.
* Finally, if a super fund that is paying a pension has most of the fund assets invested in property, then the trustees will need to consider the best time to sell the property so that pension payments can be made.
It would be prudent for trustees to avoid having to sell property in a rush.
This email is general in nature only and does not constitute or convey specific or professional advice. Legislation changes may occur quickly. Formal advice should be sought before acting in any of the areas discussed. Be aware that the information in these articles may become innaccurate with time. Responsibility is disclaimed for any inaccuracies, errors or omissions. Particular investments are neither invited nor recommended and hence this publication is not "financial product advice" as defined in Section 766B of the above legislation. All expressions of opinion by contributors are published on the basis that they are not to be regarded as expressing the official opinion of any other person or entity unless expressly stated. No responsibility for the accuracy of the opinions or information contained in the contributor's articles is accepted by any other person or entity. Copyright: This publication is copyright. If you wish to reproduce this article you require a license, which can be purchased here, to do so.