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Self Managed Super Funds and Real Property

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    Self-managed superannuation funds, often known as SMSFs, are gaining popularity as a way for people in Australia for saving money for their retirement. SMSFs have the potential to provide a number of advantages, including increased control over your finances and access to a broader variety of investment choices.

    However, it is important to keep in mind that SMSFs are not permitted to invest in real property unless particular requirements are satisfied. In this article, we will take a more in-depth look at those prerequisites and explain what steps you need to do in order to take in order to incorporate real property in the portfolio of your SMSF.

    Self-managed super funds, often known as SMSFs, provide members with a number of advantages, including increased financial autonomy and the opportunity to put their money into a broader variety of investments. Real estate is one of the assets that may be held in SMSFs, which can be beneficial for members trying to build up their funds for retirement.

    However, there are a few factors you need to bear in mind when making real estate investments through a self-managed super fund (SMSF). This post will give an introduction to the fundamentals of investing in real estate through a self-managed super fund (SMSF), as well as some pointers on how to get started.

    A superannuation fund known as a self-managed super fund (SMSF) is one in which the trustees are also the members of the fund.

    An SMSF is required under the SIS Act to accomplish two primary goals: the first is to provide retirement benefits for members and their families, and the second is to offer additional benefits relating to an individual's work, including payments upon cessation of employment.

    Many laws dictate how an SMSF can invest its funds, such as what kinds of property it is allowed to buy. One example is a piece of real estate, which can refer to either land or structures.

    A self-managed super fund, often known as an SMSF, might be an excellent choice for you if you are interested in making investments in real estate. In addition, when you manage your own retirement savings with the help of a self-managed super fund (SMSF), you have a greater amount of say over where and how your money is invested.

    And when it comes to investments in real estate, SMSFs provide a few major advantages, including the following: To begin, the Australian Tax Office grants SMSF investors the ability to claim depreciation on their property assets, which may give investors with a significant amount of tax relief.

    Second, self-managed super funds (SMSFs) have the ability to borrow money to invest in property, whereas individuals do not; this might allow you to begin investing in property sooner. Last but not least, self-managed super funds (SMSFs) may be established with as little as $200, making them a reasonably inexpensive real estate investment method.

    You have definitely heard of self-managed super funds (SMSFs), but if you're like the majority of people, you don't really understand what they are or how they function. Self-managed superannuation funds, sometimes known as SMSFs, are a particular kind of superannuation fund.

    This indicates that you, and not an accountant or a financial consultant, are in charge of determining how your fund should be invested.

    Although this may appear to be a daunting task at first glance, it may be an excellent method to take charge of your retirement funds and invest them in a way tailored to your particular requirements and aspirations. In this piece, we'll go over some of the fundamentals of SMSFs, such as how they operate and the benefits and drawbacks of establishing one for yourself.

    If you are the trustee of a self-managed super fund, often known as an SMSF, you might be contemplating making an investment in real estate. However, before making any selections about your retirement, it is essential to have a thorough understanding of the dangers and obligations that are linked with this strategy, despite the fact that it may be an excellent approach to plan for your later years.

    This article will take a more in-depth look at SMSF property investing, covering the benefits and drawbacks of this form of investment. We'll also share some advice for getting started. Continue reading this article if you are considering extending your SMSF investment portfolio to include real estate investments.

    Let's get started!

    Introduction

    1. SMSFs

    Self-managed superannuation funds, also known as self-managed super funds or SMSFs, are quickly becoming (if they aren't already) the prefered investment vehicle for a large number of people. This is comparable to the role that family trusts have played for a number of years prior to the present time.

    It is not hard to fathom why people gravitate towards superannuation funds in general: concessional tax conditions, tax discounts to encourage contributions, and mandated participation.

    In the area of superannuation, we believe that the vast majority of advisers are aware of the reasons why SMSFs are so widely used. To speak in very broad terms, SMSFs provide the investor or retiree with the following benefits:

    • discretion over how their own retirement savings are invested; 
    • lower costs (or at least the illusion of reduced prices!).

    In Australia, there are around 300,000 self-managed funds, and the number of these funds is expanding at a rate of more than 2,000 each month.

    We believe there is little room for question regarding the fact that SMSFs will continue to gain popularity. In recent years, there has been a spectacular growth in the regulation of superannuation institutions, particularly with regard to the ramifications that the FSR law has brought about.

    We have also had another degree of regulation put on super funds (other than SMSFs) under the Super Safety Amendment Act, which mandates that funds must be registered, and trustees must be licenced. This additional level of regulation applies only to funds that are not SMSFs.

    In addition, there will be prerequisites for risk management strategies and plans and new standards for what constitutes a "fit and appropriate individual." These criteria become mandatory on July 1, 2004, however, there will be a transition period of two years before they are fully implemented.

    It is required that "Choice of Fund" be made available to a significant number of workers so that they can take advantage of the new portability criteria.

    1. Property investments

    There has, of course, also been a significant rise in the number of customers from all walks of life and ideological backgrounds who are considering making financial investments in real estate. This now extends to typical arm's length investments and clients who desire to hold their own commercial real estate (including farming land) more efficiently.

    1. SMSFs and property investments

    As SMSFs and real estate investments have become increasingly popular, customers have naturally begun to inquire whether or not they should hold their property holdings through SMSFs and, if so, how they should do so.

    Additionally, as the amount of money that people have invested in superannuation has grown, some people have begun to view the purchase of property from a member or a related entity as an investment opportunity. This is because the purchase of property from a member or related entity enables the member to withdraw cash from the fund sooner than it would be otherwise possible, either for their own personal use or to use in the operation of the relevant business itself - without actually losing access to or use of, the property.

    1. Purpose of this paper

    This article aims to investigate the challenges of making an investment in real estate using an SMSF, as well as some of the approaches currently being taken in this field.

    We are not going to go into all of the basic benefits and drawbacks of superannuation funds here. Instead, we will operate under the assumption that a broad awareness of problems such as the availability of deductions for contributions to superannuation funds, the tax or surcharge on contributions received by the fund, how benefits are taxed, etc., is held by the reader.

    When Is The Concession Available?

    This exemption is granted in the event that all of the following conditions are met: 

    • (1) the transferor is the only member of the super fund; and 
    • (2) the property will be kept solely for the transferor's benefit. In the event that more than one member is transferring the property, the property is to be used for the benefit of those members only and in the same proportions as they held it prior to the transfer; and the property is solely used to provide a retirement benefit to the member who is transferring it (s).

    If the transaction includes a transferor moving property into their SMSF, which has two or more members, the issue is slightly more difficult than it would be otherwise.

    This is due to the fact that the Duties Act 1997 (NSW) states that the property or the proceeds from the sale of the property cannot be "pooled" with the property or funds held by other members of the SMSF, nor can other members receive any interest in the property. The Duties Act 1997 (NSW) also states that other members cannot receive any interest in the property.

    Please get in touch with us if you think this would make things more difficult for you given the circumstances; our stamp duty experts will be happy to assist you in completing this obligation.

    Imagine that the SMSF needs to borrow money in order to purchase the property and that the monies are then transferred to the SMSF's custodian.

    In such a scenario, an extra duty in the amount of $500 must be paid on a declaration of trust issued by a custodian of the trustee of an SMSF, stating that the property in question is or is to be held in trust for the trustee of the SMSF.

    Methodology And Purpose

    1. Getting property into an SMSF

    The member (as a personal contribution) or the member's employer can make an in-specie contribution of the entirety of a property to the fund;

    •  the SMSF (already having money in it) can buy the entirety of the property, either from a member (or a related entity) or from a third party who is not related to any of the members in the fund; 
    • and finally, real property can be transferred into an SMSF through a number of different mechanisms.
    1. Getting property out of an SMSF

    The same analysis is applicable regarding the process of withdrawing the property from the SMSF at the appropriate time. 

    • That is to say, the SMSF has the ability to provide the entire property in its entirety to the member for the purpose of providing for their benefit; 
    • alternatively, the SMSF has the ability to sell the entire property, either to the member or to a third party.
    1. Co-ownership

    It is acceptable for an SMSF to buy property in partnership with another person or entity. Therefore, in any of the scenarios described in paragraphs 2.1 and 2.2, the exact same technique for acquiring or selling the property might be applied to a portion of an interest in it.

    As a consequence of this, some strategies have been developed that involve "drip-feeding" an interest in a property into an SMSF over the course of several financial years in order to achieve a desired overall result in terms of the available deductions, the amount of CGT liabilities, that are manageable, etc.

    This is, of course, subject to the standard prudential restrictions that apply to an SMSF and will be explained in further detail later on in this paper.

    1. Trust deed

    When dealing with a superannuation fund, especially with an SMSF, it is essential always to pay careful attention to the fund's trust deed. We have discussed donations made in kind as well as the distribution of benefits through contributions in kind.

    In the not-too-distant future, we shall discuss the many kinds of investments that an SMSF can and cannot make, such as the purchase of real estate followed by the leasing of that property. In any one of these situations, even if SIS permits the specific manner of purchase or later investment, it will only be approved if the trust deed permits it. This is true regardless of whether or not SIS permits it.

    Finding a solution that can replace the necessity of physically reviewing the trust deed is impossible. However, it is typically feasible to make changes to it to permit the actions you wish to do, even if it is lacking in some particular manner. Therefore, it is in your best interest to get started on this process as soon as possible!

    Types Of Property

    It would appear that there are just two primary categories of property that we are required to take into consideration within the scope of this discussion. First, to begin, the term "real business property." Second, any other type of land or building that is owned.

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    Normal real property is subject to the same regulations, restrictions, and limits as other real property. However, at least to some extent, certain of these requirements are waived when it comes to the ownership of real estate used for business purposes.

    When it comes to the category of "any other form of property," the subcategories that are most frequently inquired about are the following: 

    • commercial investment property; 
    • residential investment property; 
    • the home; 
    • and the beach house.

    It is essential to keep in mind that it is not true that an SMSF may only invest in commercial real estate, as this misconception is commonly held. The general norm is that a self-managed super fund (SMSF) has complete leeway to invest in various types of real estate as long as it abides by the prudential regulations regulating super funds. That is true for residential as well as commercial property.

    The member (or an associate) wants to live in or use the investment (for example, the home, the beach house, or the business premises); the property concerned is already owned by the member (or an associate); the real problems with property investments only arise in the circumstances where: the member (or an associate) wants to live in or use the investment (for example, the home, the beach house, or the business premises).

    Suppose, for example, that an SMSF wants to make an investment in a residential property that is now held by a person who is not linked to the SMSF and that, following the acquisition, is going to be rented out to people who are not related to the SMSF. There is a very low chance that there will be a significant amount of problems with that investment.

    And the distinction between business real property and other property is only relevant when either of the following conditions are met: 

    • the property that the SMSF wishes to acquire is owned by a member of the SMSF (or an associate); 
    • or the SMSF intends to lease the property to a member after acquiring it (or an associate).

    However, the difference becomes quite important in certain instances.

    Business Real Property

    1. General philosophy

    The government has gone out of its way to make it feasible for self-managed superannuation funds, sometimes known as SMSFs, to acquire an interest in the property that is utilised (directly or indirectly) by the member in the operation of their business.

    As most people would be aware, the thrust of many of the investment restrictions is exactly the opposite - to make sure that a member's super fund money is not invested in any way that might jeopardise if the business runs into difficulty.

    The Australian Taxation Office (ATO) acknowledged in a draught circular on this issue that "the business real property exclusions give headroom for small company owners to utilise their superannuation funds to invest in their business premises." I shall cover this in more detail shortly.

    The exclusions acknowledge that land and buildings typically have an underlying value that is separate from the operation of a linked entity's business (sic.).

    In rare circumstances, residential property can only be properly described as real business property. However, in THAT SAME CIRCULAR, the ATO has noted that the government has already considered "the issue of extending the definition of business real property to include residential property was considered." This indicates that the government has already considered expanding the definition of business real property to include residential property.

    Because the intention behind providing the exceptions was to enhance the capability of small business owners to use their superannuation savings to invest in their business premises, it was determined that there were no grounds to extend the business real property exception to include residential property. This conclusion was reached because the exceptions were provided.

    1. ATO circular

    Regarding self-managed superannuation funds (SMSFs), the ATO has disseminated a draught of Superannuation Circular 2003/xx with the intention of defining what constitutes "real business property."

    In the circular, the ATO comes to a number of findings about real estate used for commercial purposes. It is impossible, in our opinion, to disagree with any of their findings or conclusions.

    The circular evidence led to the following set of findings, which are presented in list form. (It is important to note that the following paragraphs contain verbatim quotes from the draught circular in some, but not all, instances.)

    An SMSF is now permitted to use up to one hundred percent of its assets to purchase commercial real estate, provided the property is at fair market value.

    In order for a piece of real estate to qualify as business real estate, it must have been utilised entirely and exclusively in one or more enterprises, either from the time the SMSF purchased it to the end of the lease term with a related party3 or from the time the SMSF purchased it.

    For the sake of this discussion, the term "business" refers to its traditional sense of meaning, which encompasses both primary production and the supply of professional services. Therefore, the status of employee is expressly disqualified for consideration.

    It makes little difference who runs the company as long as it succeeds. Therefore, it is not necessary for whomever owns the property to continue doing it in any way. The sole stipulation that must be met is that the land be utilised entirely and solely for commercial purposes.

    To qualify as being utilised "wholly and exclusively" for commercial purposes, the property in question must be put to use in one or more enterprises to the exclusion of any and all other uses. Take, for instance, a situation in which just a portion of the land is utilised for commercial reasons while the other space is put to residential use. In such a scenario, it is unlikely that the property in question will qualify as commercial real estate.

    In most cases, the criterion that the property be used for business purposes will not be satisfied by residential property, and as a result, residential property will not qualify as commercial real property. The simple act of leasing out a piece of real estate does not in and of itself establish the operation of a company.

    It is necessary to examine each individual situation in order to establish whether or not a business is being operated. For further information, please refer to paragraph 24 of the APRA Superannuation Circular II.D.3. It is necessary for there to be some "organised" activity, which can be demonstrated by the following: 

    • the maintenance of separate records; 
    • the size of the operation and the extent to which capital investment is involved; 
    • whether the transactions that are conducted are carried out continuously and systematically or in an ad hoc fashion; 
    • and the involvement of employees.

    Real estate owned by one or more businesses but only partially utilised by such firms is not considered business real estate. For example, consider the case of a doctor who works out of their home and dedicates a portion of their property to their medical operation.

    Another common scenario is that of a person who runs their business from their own garage at home. In either of these scenarios, the exemption for commercial real property will not be applicable since the real property in question does not satisfy the condition that it be used entirely and exclusively for business.

    Real estate held in trading stock can be considered business real estate because the phrase "used entirely and exclusively in one or more enterprises" encompasses a sufficiently broad definition to allow for its inclusion. Real estate held by a property developer for the purpose of development or redevelopment or currently in the process of being developed or redeveloped is often considered real business property.

    In most cases, undeveloped land will not be considered company real property.

    Real estate that is used for farming or other forms of primary production might be considered part of a company's inventory of real estate.

    Many people can share ownership of a piece of land. However, even though an SMSF is one of the co-owners of a property, the property may still be considered real business property if it is utilised entirely and exclusively in one or more enterprises. This is a requirement for the property to be considered real business property.

    If the investment passes the "single-purpose test," a Self-Managed Superannuation Fund (SMSF) will be allowed to put its money towards making renovations to the real estate owned by the firm (which is outlined in further detail below).

    The trustee will, however, need to satisfy themselves that the cost is made purely for the purpose of the SMSF generating a larger return on the real business property in order for the SMSF to be able to offer retirement benefits to the members of the funds.

    1. ATO Interpretative Decisions

    Additionally, we should add three important IDs that the ATO has granted.

    The Australian Taxation Office (ATO) came to the conclusion in the case ID 2002/732 that the property in question did not qualify as real business property for the following reasons: 

    • the property in question was residential; 
    • the property in question was rented to third parties both before and after the SMSF acquired it; 
    • this particular property was the only investment property that the members of the SMSF owned.

    The ATO referred to IT 2423, which states that "an individual who derives income from one or two residential properties would not normally be thought of as carrying on a business." In other words, the ATO does not consider a person who earns income from one or two residential properties to be operating a business.

    The leasing of the residential property did not qualify as operating a "business" in any sense of the term.

    In its decision ID 2003/807, the ATO came to the conclusion that the property in question qualified as real business property in the following scenario:

    • The home was a standalone apartment located within a huge apartment complex;
    • Each of the units served as a place to stay for a shorter period of time;
    • Independent and qualified professionals managed the entire block of flats.
    • The block's income and expenses were combined into a single pot, and the nett income was divided not in accordance with the number of occupied units but rather with the total number of units held by each owner;
    • The owners did not live in any of the flats themselves.

    The Australian Taxation Office came to the conclusion in the case ID 2004/92 that the property in question did not qualify as real business property for the following reasons: 

    • the property in question was residential; 
    • a property manager managed the property; 
    • and the owner received nett income based on occupancy.

    Even though it was common knowledge that the manager was running a company, it was never established that the owner or the management utilised the property for any kind of commercial activity.

    In relation to the property, the manager's only role was that of an agent working on behalf of the property's owner. Therefore, he was not engaged in the actual business of managing the property.

    What Is An In Specie Transfer?

    Although it may seem more like extraterrestrial kidnapping, the term "transfer" in the superannuation context refers to something much more grounded.

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    Contributing money to one's own self-managed super fund (SMSF) account is likely something that self-managed super fund (SMSF) trustees are already familiar with. On the other side, you might not be as knowledgeable about the procedure involved in transferring an asset such as property or shares into or out of your fund without exchanging any money.

    Transfers of assets into and out of super funds that do not involve turning the assets into cash are referred to as in-specie transfers. This type of transfer is also known as an off-market transfer. The English translation of the Latin term "in specie" is "in the actual form."

    There is a set of rigorous guidelines to follow for anything amazing. To start, all physical commodities transactions must occur at their present market value. There is a possibility that this will also have an effect on the contribution limits and tax position you have.

    Transfers of physical assets are utilised more frequently in SMSFs than they are in super public funds. It is thought that several industrial funds are considering accepting shares as a form of contribution, and some retail super funds currently take shares as a form of contribution. However, the topic of specie transfers concerning SMSFs is this article's exclusive subject.

    When transferring assets to an SMSF, Avoiding In-Specie Traps

    When SMSFs make transactions in-specie, certain tax ramifications and compliance difficulties need to be considered, as a legal company that specialises in SMSFs has pointed out.

    In a recent update, Steve Jell, a senior associate at Cooper Grace Ward, stated that the considerations regarding contributions are relevant when transferring assets to an SMSF because the SMSF will need to treat the asset transferred as a contribution. This is because the SMSF will be required to treat the asset transferred as a contribution.

    "It is possible for a member to make a contribution or for another person to do so on their behalf. However, both the kinds of assets that may be moved into an SMSF and the ways in which those assets can be accounted for are subject to restrictions imposed by the super regulations, "Mr Jell added.

    "The individual member is often the one who intends to transfer an asset that belongs to another municipality into their own SMSF. But unfortunately, this results in the fund having some compliance issues. This is because each member will be treated as a related party of the fund, and the SMSF has some restrictions on the assets that it can acquire from a related party. Consequently, the fund will have some trouble meeting its regulatory requirements."

    In general, three different kinds of assets can be transferred to an SMSF. Mr. Jell pointed out that this include listed assets such as shares that are traded on the ASX, managed funds, which are a specific kind of investment in which the member is just one of many investors, and real estate that is utilised in a company, such as commercial property.

    However, before transferring an asset, according to Mr. Jell, counsellors will need to look at the unique circumstances and the item that will be moved in.

    "All right, let's start by taking a look at the trust deed. Does it permit the transfer of different types of currency? Does it call for a certain procedure that must be carried out in a certain way? Mr. Jell made the observation that the asset itself must be transferred at its market value.

    "Therefore, when we are considering market value transfers, we need to think about whether or not the member has enough room in their contribution limitations to enable them to have the allocation of that asset to their member balance,"

    Suppose the individual member is the one moving it out of their name. In that case, we need to look at the tax repercussions connected with them disposing of that asset individually since it will most likely be recognised as a tax event for the purposes of capital gains tax.

    According to Mr. Jell, the SMSF has to examine the transfer duty ramifications of moving real estate into the SMSF since the beneficial owner of the asset will have changed when the real estate is transferred into the SMSF. This is the case if the SMSF is transferring real estate.

    What kinds of paperwork do we need to get ready? Naturally, and they will be determined by the conditions that are involved with the specific transaction," he clarified.

    Once an item has been added to a fund, it is possible that it will be very difficult to remove it from the fund. This is the most important consideration in each of these scenarios. Consequently, we have to consider whether or not the members wish to keep that asset in the SMSF for a long time.

    Relevant Sis Restrictions/Prohibitions

    1. General

    When transferring real property into an SMSF, a number of pertinent restrictions and prohibitions are included in the SIS Act that need to be considered. We will now turn our attention to these provisions. A few of them will also be relevant when it comes to removing the property once more.

    1. Sole Purpose Test

    We have a strong suspicion that everybody who has ever had even a passing acquaintance with retirement savings plans is familiar with the sole purpose test.

    A superannuation fund must, in essence, be maintained solely to give benefits to the member at retirement, upon reaching age 65, or upon the member's death, whichever occurs first. Several more tangential advantages are also being taken into consideration (e.g. salary continuance insurance).

    It is not simple to understand precisely how the ATO or the courts use the single-purpose test in their decisions. We believe that applying the tried-and-true "smell test" is the most straightforward method to approach this issue in your thinking.

    If a fund intends to enter into an arrangement that in any way gives a benefit to a member other than when they retire, then there is at least some possibility that the fund will fail the single purpose test.

    It is permissible to take advantage of some "incidental advantages." Investment in a holiday property (rented on a commercial basis) and for which there is a reasonable expectation that commercial occupancy rates would be achieved may incidentally be available to members on a commercial basis, according to APRA Superannuation Circular No. III.A.4 in the context of real property.

    1. Investment Strategy

    A trustee of a fund is required to "formulate and give effect to an investment strategy that has regard to the whole of the circumstances of the entity," according to section 52 of the SIS Act. We also suspect that anyone who has previously dealt with SMSFs is aware of this requirement, which can be found in the SIS Act. This provision states that the trustee of a fund must fulfil this requirement.

    If an SMSF is going to invest in real estate, the SMSF's investment plan must first allow it to do so. This is true even if the SMSF chooses to acquire the property through one of the other purchase strategies that I have already mentioned. In the event that such an investment is considered, but the investment strategy does not permit it, the investment strategy will need to be modified in the necessary manner before it can be used to permit such an investment.

    Any such investment approach would need to consider a number of different aspects. For example, the phrase "risk," "asset diversification," "liquidity," and "the ability to discharge existing and potential liabilities" are all included within Section 52 itself.

    In the context of an intended investment in real property: 

    • the anticipated rental return would need to be mentioned; 
    • the risk concerning the property itself is probably not going to be that high, as is inherently recognised in the policy of specifically allowing SMSFs to hold real business property; and the potential for capital loss from the property itself is probably not going to be that high (see paragraph 4.1 above) - however, it might be worthwhile to include something in the investment strategy that deals with what occurs in the event that the business to which the property is being leased fails (i.e., are there good prospects of getting another tenant); 
    • the lack of liquidity of this type of investment is an important factor that needs to be addressed - properly is not as easy to convert into cash as is a share portfolio. Nevertheless, the anticipated timescale during which the fund would have to pay its benefits (for example, the members' retirement in thirty years) will frequently decrease the problem that would otherwise be confronted with this form of investment.

    It has, in our opinion, always been viable to invest the entirety of an SMSF in a single asset so long as the proper investment strategy problems have first been addressed. We believe this has always been the case from the perspective of variety. In a very real sense, this has been validated by the provisions of section 66 itself (see paragraph 5.7 below).

    It is also essential to remember that the SMSF investment plan cannot simply be decided upon at the time of the first property purchase and then ignored afterwards.

    It will be required to review this topic on occasion as the contributors advance in age, and the fund's investments undergo shifts in the future. In particular, once a member of an SMSF retires, and the fund begins paying a pension to the member, the fund should continually be revising its investment strategy. But, again, this is because the person's investment needs will change.

    For the member to get the minimal yearly pension, the SMSF will need to generate at least enough revenue to cover the cost of the pension. In any other case, it will be necessary for it to either sell the investment and engage in other, more liquid forms of investment or distribute some of the fund's capital, which would be difficult if the property was the only investment in the fund (although it could be distributed in part interests).

    The trustee(s) are responsible for adequately documenting a suitable investment plan at all times; this strategy should then be maintained and revised as required.

    1. Borrowing/Security Prohibition

    Borrowing money by the trustee of a superannuation fund is prohibited by section 67 of the SIS Act, which also applies to SMSFs. There are a few exemptions to that general restriction, but they don't really matter when it comes to dealing with property transfers.

    It is against the rules of the SIS Regulations for the trustee of a fund to give a charge over or affecting an asset, as stated in Regulation 13.14. However, a mortgage can be considered a "charge" according to one definition.

    As a result, an SMSF cannot take out a loan to purchase the property or use that real property as collateral (e.g., guarantee security).

    These limitations, of course, resulted in the widespread usage of unit trusts to have the borrowing necessary to buy a specific property performed at the unit trust level rather than the unitholders' level.

    The modifications that were made to the in-house asset rules in 1999 had the consequence of creating legislation that was hostile to these arrangements. To reiterate, I will be discussing this topic in greater depth in a moment.

    It is important that I bring up co-ownership in the context of the ban against charging an asset that belongs to the fund. Take, for instance, the scenario in which an SMSF and a non-superannuation business jointly possess a piece of land.

    In this scenario, it is theoretically feasible for the non-superannuation entity to take out a mortgage over that entity's interest in the land, but the SMSF would be able to keep its stake in the land free and clear of any costs.

    The Australian Prudential Regulation Authority (APRA) stated that it would be willing to accept such an arrangement in a circular that dealt with in-house assets (Superannuation Circular No. II.D.6).

    However, if a related party intended to utilise its investment in the property as security against borrowings, the trustee would be better off not investing as a tenant in common in the property in question. This would be the more responsible course of action.

    APRA continued by stating that the appropriate protection would be to obtain a written undertaking from the mortgagee that the fund's share of the proceeds of any forced sale would receive priority and would, as a result, be paid to the super fund. This was APRA's recommendation for providing adequate protection.

    We have to acknowledge that all of this is technically conceivable; but I find it hard to believe that a significant number of financial institutions would have any special interest in pursuing this kind of framework or giving that sort of commitment.

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    1. Loans to Members

    This is not exactly relevant to the investments that SMSFs can make in real property. However, in spite of this, it is important to note that typical investments in real estate are not allowed within a self-managed superannuation fund (SMSF), thus, these kinds of transactions must take place outside of the fund (e.g. a home or holiday house).

    It is against the law for the trustee of a superannuation fund to lend money to a member of the fund or a family of a member of the fund or to provide any other kind of financial aid using the resources of the fund, according to Section 65 of the SIS Act.

    On the surface, this indicates that an SMSF will not be allowed to lend money to a member or a related of the fund in order to facilitate the member's or the relative's investment in real estate.

    This will be the case regardless of whether the borrowing is done on fair terms with regard to interest and repayment, whether the SMSF has adequate security (a first mortgage, for example), or any other factor.

    However, there is a loophole in this rule that allows one thing. If the fund in question was founded before the 16th of December 1985, and if, before that date, the trustee had the express right to lend money to members, then the trustee is still authorised to do so if the fund was established before that day.

    It is highly likely that provisions allowing the trustee of a personal superannuation fund to lend money to a member of the fund or a member's relative were included in the fund's original trust deed if the fund was established before December 1985. However, in order to qualify for a loan, the trustee needed to ensure that certain conditions were met (as to the interest, security etc.).

    In the event that this trust deed still possesses that authority, then it may still be able to lend money despite the fact that doing so would normally be forbidden. If these provisions have been changed or eliminated since then (perhaps by an unintentional, off-the-shelf mass deed replacement at the time when SIS came in), then that chance is no longer accessible. Otherwise, it is still possible to take use of it.

    We suppose it is possible for a person to roll over their benefits into a "old" fund (of either a relative or a person who is not related to them) to take advantage of that fund's pre-existing ability to lend money to members. But, again, this could be done by a relative or a person who is unrelated to them.

    It's possible that such a tactic wouldn't pass the "single-purpose test" when put to the test. Because a loan to a member or a member's family would be considered an in-house asset and consequently subject to the limits set forth in paragraph 5.8 below, the feasible application of this method would, in any event, be quite restricted. This is because the restrictions would apply to the loan.

    1. Arm's length transactions

    In accordance with the provisions of section 109 of the SIS Act, a trustee is not permitted to make an investment unless both the trustee and the other party to the relevant transaction are conducting themselves in a manner that is independent of one another in regard to the transaction.

    The price at which the property is transferred to or from the SMSF (either on sale or by way of contribution/distribution) must be an arm's length sale price; and after the acquisition, if the property is leased to a non-length arm's party, the main terms on which the property is leased to that other party must be the same as those on which the property was leased to the SMSF. These are the critical issues that must be addressed in order to satisfy this requirement in the context

    The trustee will be responsible for providing evidence that the SMSF has complied with this requirement in the event of any subsequent audit of the SMSF. It is possible that the trustee will also be responsible for persuading the auditor that this is the case.

    In either of these cases, the acquisition of an independent valuation completed before the relevant component of the deal will prove to be quite beneficial.

    Concerning the transfer of property from a non-length arm's party to an SMSF, I suggest that the following issues also need to be considered: 

    • whether or not a formal contract should be entered into; 
    • whether or not adjustments should be made as to rates and taxes; 
    • who should bear the costs associated with the transaction; 
    • and whether or not an adjustment should be made as to whether or not an adjustment should be made as to rates and taxes (including stamp duty, registration fees and legal fees).

    In our opinion, the response to some of these issues will be contingent on whether the SMSF is acquiring the property through an in-specie contribution or through a "regular" acquisition. This is because in-specie contributions are treated differently from "normal" purchases.

    Suppose it is doing so through the donation of actual goods. In that case, it doesn't really matter who is responsible for the stamp duty and other associated charges (although, in my view, it is best to have the contributor do so).

    If, on the other hand, the SMSF is purchasing the property with its own funds, then it should shoulder these costs precisely as it would if it were purchasing the property from a third party who was not related to it in any way. In other words, the SMSF ought to be responsible for paying the stamp duty, the registration fees, and any other charges that a purchaser typically handles.

    Concerning the leasing of the property to a party that is not at an arm's length from either party, it seems to me that the following issues are pertinent: 

    • whether or not a formal lease should be entered into;
    • whether or not the usual disclosure forms should be served on the tenant;
    •  and who should be responsible for bearing the costs that are associated with the transaction (including registration fees and legal fees).

    Additionally, the SMSF's property investment must continue to be managed on a premise of complete independence at all times. Even if the lessee's default may be connected to the SMSF that owns the property, the SMSF is obligated to take the required procedures to enforce its rights in the event that there is a default by the lessee.

    1. Acquisition of Assets from a Member

    The trustee of a superannuation fund is prohibited from purchasing an asset from a related person under the provisions of section 66, which is a general ban.

    [The term'related party' refers to anyone who is either a member of the fund or an employer-sponsor of the fund who falls into the standard category. A "Part 8 Associate" is a term that is defined in sections 70B, 70C, and 70D of the SIS Act. In (very) general terms, this term refers to the following people and entities: 

    • a relative of the member; 
    • other members of the fund; 
    • the member's partner and the partner's spouse; 
    • a trust that the member controls; 
    • a company that is "sufficiently influenced" by the member; 
    • and any other person or entity that meets the aforementioned criteria.
    1. In-house Assets

    On August 11, 1999, the newly enacted laws pertaining to 'in-house assets' went into force. Investments made before that date were subject to other limits, which were more permissive. The new regulations did not apply to any further investments that were made between the 11th of August 1999 and the 23rd of December 1999 since they were not made until the 1st of July 2001.

    In addition, some kinds of investments are subject to the application of a number of other transitory restrictions. On the other hand, due to the fact that such investments were made some four or five years ago, I do not want to go into depth about them in this paper.

    According to subsection (1) of section 71, a "in-house asset" is an asset of the fund that meets one of the following criteria: 

    • the asset is either a loan to or an investment in a related party of the fund; 
    • the asset is either an investment in a related trust of the fund; 
    • the asset is subject to a lease arrangement with a related party of the fund.

    [In the preceding paragraph, number 5.7, we covered the topic of what constitutes a linked party (a). According to section 70E, a trust is considered to be "connected" if the member of the fund (or the typical employer-sponsor of the fund) "controls" the trust.

    Insofar as property acquisitions are concerned, the pertinent considerations are as follows: 

    • an investment made by an SMSF in a related unit trust will be considered an in-house asset; 
    • and the leasing of property (either real business or other property) to a related party will result in the leased property being considered an in-house asset. Both considerations apply whether the property in question is real business or other property.

    It is permissible for a self-managed superannuation fund and any other type of superannuation fund to hold in-house assets; however, the proportion of in-house assets held cannot exceed 5 percent of the total market value of the fund's assets. At the conclusion of each fiscal year, a review of this permissible ratio is scheduled to take place.

    Suppose, at the conclusion of one fiscal year, it is discovered that the 5 percent limit has been exceeded. In that case, the trustee(s) in charge of the organisation are obligated to make a strategy to bring the level of in-house assets down to 5 percent or less by the end of the next fiscal year.

    The following assets are not included in the definition of "in-house assets" (there are more exclusions, but these are the ones that apply to real property):

    • real property that is leased by an SMSF to a related party so long as, throughout the term of the lease, the property is business real property (section 71(1)(g)); 
    • real property that is owned by a fund and a related party as tenants in common (but not if that property is leased to a related party) (section 71(1)(i)). 

    The real property doesn't need to have been purchased from a related party in order for the transaction to qualify under subparagraph (g). As a consequence, it will apply to whoever it was that the SMSF purchased the real property from.

    It is not quite apparent if clause I indicates that a commercial real property owned jointly by the SMSF with a related party and that is leased to a related party is an exemption. This is because the language is not totally clear. We think that the best interpretation is that paragraph (g) would apply in that circumstance to prevent the property from being considered an in-house asset. This is because paragraph (g) states that the property cannot be used for business purposes.

    When a self-managed super fund (SMSF) owns shares or units in a unit trust or a firm, the shares or units are typically regarded as belonging to the SMSF's "in-house" asset pool. However, they will not be considered in-house assets if the company or trust: 

    • does not borrow; 
    • does not encumber its assets; 
    • does not invest in or loan money to other entities (not including banks or other financial institutions);
    •  has not acquired an asset from a related party after August 11, 1999, other than real business property;
    •  has not acquired an asset that a related party had owned within the previous three years, other than real business property at market value; 
    • does not directly or indirectly lease as an operating business; does not lease as

    Is There A CGT Event When An Asset Is Rolled Over To Another SMSF?

    Imagine that I am the sole member of SMSF 1 and that I decide to move assets over to SMSF 2, where I would likewise be the only member: will this result in a CGT event?

    There are others that respond with a negative. The answer is "no" because the presumption is that because I am the only one contributing to each fund, I am also the only person who would benefit from those funds. As a result, there has been no change in the beneficial ownership, and there has been no CGT event.

    This line of reasoning, and the result it leads to, is incorrect, however, for a number of different reasons.

    To begin, it is quite improbable that I will be the only beneficiary of an SMSF, even if I am the only member of the SMSF. The most important decision was Kafataris v. Deputy Commissioner of Taxation (2008), 172 Federal Court of Review 242. In a nutshell, Kafataris's research lends credence to the notion that beneficiaries of an SMSF comprise not just the fund's members but anybody else who could profit from the fund at some point in the future.

    Second, it should not be assumed that anybody has a rightful claim to the beneficial ownership of anything.

    Last but not least, the CGT laws are not worded in that manner at all. This is the most essential point. For instance, the Income Tax Assessment Act 1997 (Cth) states that a "CGT event E2 happens if you transfer a CGT asset to an existing trust," and this definition can be found in section 104 60 of the act. Therefore, it is only logical that the new SMSF will be an expansion of an existing trust.

    This capital gains tax event will not take place for you if "you are the beneficiary and... you are indisputably entitled to the asset." This is an exception to the general rule. However, Kafataris demonstrates that this exemption will practically never apply to an SMSF and provides evidence to support this claim.

    To summarise, transferring assets from one SMSF to another does, in fact, result in the production of a CGT event.

     

    Qualifying as an SMSF

    Be a superannuation fund; Have fewer than five members; andHave each member as either an individual trustee of the fund or the director of a corporate trustee (and vice versa). Somewhat surprisingly, only about 30 per cent of SMSFs have corporate trustees.

    There's no minimum balance required to set up an SMSF, but it usually becomes cost-effective once you have a balance of $250,000 or more. You will need to pay the annual supervisory levy to the ATO and arrange for an accountant to prepare the financial statements and tax return, and conduct an independent audit.

    An SMSF must have four or less members. Being a member of the fund also means you must be a trustee. You can have a company as a trustee but all members must be directors. All trustees are responsible for the running of the fund and should act in the best interests of all fund members when making decisions.

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