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Self Managed Super Fund (SMSF) Article
Careful how you handle that investment property
By Tony Negline.
This article may be out of date.
8th July 2009
A regular reader of this column recently posed the following question – "I've run my own super fund for almost 30 years and I'm about to retire when the fund will begin to pay me an account based pension. The major asset in my fund is an investment property which the fund bought in 2001. It has been a terrific investment. I'm not sure what I want to do with the property. I might want to live in it at some stage, my children might like to own it when I die or my grandchildren might like to live in it for a short time when they're young adults. What issues should I consider"?
This reader, who we will call Tom, has a vast number of issues to consider when planning how this asset will be used to pay him a pension.
Firstly, will the fund have access to sufficient capital to pay at least the minimum income payments over the long-term? By definition a pension is an investment which pays income to the nominated pensioner at least once per year. This means that the assets backing a pension have to be structured to generate income. Over time however the current regulated minimum pension payment requirements will force a trustee to sell assets in order to pay the annual income payments.
It's for these reasons that the assets underlying many pensions are a range of investments that not only generate income but can also be easily split up and, if necessary, sold in parts to ensure a fund always has sufficient money to pay a income payments.
Tom has told us that the major asset in the fund is an investment property. It's often not possible to sell segments of one piece of real estate. It is also likely that the property will not generate sufficient capital over the long-term to pay the ever increasing minimum income payments. At some point Tom's super fund trustees will need to decide what to do with the property from a pension paying perspective.
One option will be for the super fund trustee to sell the asset whilst the pension is still running. This will obviously provide cash to make income payments.
One of the advantages of selling the property whilst it's supporting a pension is that all capital gains will be exempt from Capital Gains Tax. This exemption arises because a super fund's pension assets aren't tax – the technical taxing point is the recipient of the income paid. If that income recipient is over 60 then most income payments are paid out tax-free – no tax in the fund and no tax in the hands of the investor.
Tom has suggested that he or his grandchildren might one day live in the property. The super laws do not allow Tom or his relatives, who include his children's children, to use a super fund asset in this way. The penalties for breaching the super rules in this way are quite severe – potentially a loss of super fund tax concessions and also potentially fines for the trustee and anyone else knowingly involved in the breach of the super laws.
Ultimately if Tom or his grandchildren to decide to live in the property then an option to consider may be to transfer the property to him whilst the fund is paying him a pension. The fancy technical term for this transaction is "in specie partial commutation".
The super laws allow lump sums to be paid in kind but according to the super regulators, demand that actual pension payments be paid with cash, cheque or bank electronic transfer.
Although the super laws might allow for this lump sum transfer, Tom needs to check his super fund's trust deed to ensure that it can actually pay an in specie lump sum benefit.
Before a transaction like this takes place, the costs of completing the transaction needs to be considered. A transfer of this type may well attract ad valorem stamp duty. Other costs such as legal, accounting and advice fees should also be factored in. Finally, Tom's super fund trustees have to consider Capital Gains Tax.
One might assume that CGT would not apply to this type of transaction because the asset is being used to support a pension which is not taxed in the super environment as detailed above.
Account-based type pensions have been available in the Australian superannuation landscape for over 15 years. Since that time most, if not all, super providers and administrators would pay this lump sum benefit out and assume that no CGT would be payable for assets deemed to be sold on partial commutations.
Unfortunately the law in this respect is not clear. A spokesman from the Tax Office said that they are aware of the transaction but they are yet to form a definitive view. In any case he said that Tom's transaction probably doesn't occur very often.
Most people want to avoid arguments with the ATO and assuming Tom's super fund trustees have this view, how would they be certain that their CGT assumptions are correct?
Perhaps the only way is to apply for a Private Binding Ruling (PBR) from the ATO. The ATO spokesman told us that they have yet to receive any PBR request about this issue. The first such request will force the ATO to develop a definitive view and will impact all super funds.
Finally Tom expressed the desire that at some future time his children might own the asset. He will have two options – he can either distribute before death or after death. More on the tax implications of these two options on another occasion.
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