When considering the purchase of commercial real estate via your Self-Managed Super Fund (SMSF), and potentially leasing it back to your own business, it’s essential to be aware that this process resembles a standard real estate acquisition. However, specific steps with the help and support of your Perth SMSF tax accountant must be adhered to comply with superannuation and tax regulations:
Step 1: Verify Your Investment Strategy and Trust Deed
Before using borrowed funds to invest in commercial real estate for your SMSF, ensure the property aligns with the fund’s investment strategy. This includes considerations like asset diversification, liquidity, and maximisation of member returns.
Adjustments to the investment strategy might be needed, particularly to address any lack of diversification due to the Limited Recourse Borrowing Arrangement (LRBA) and the trustees’ plans to manage this.
Step 2: Confirm the Property is Business Real Property
The commercial property must meet the Australian Taxation Office’s (ATO) criteria for business real property to bypass usual in-house asset and related party acquisition constraints. This generally includes land and buildings used solely for business purposes, meeting the business use test.
The business use test requires that the property be used entirely for business by any entity, including types like commercial or industrial properties, offices, warehouses, shops, or farms.
Farms engaged in primary production can still pass the test if they include a dwelling for private use, provided it’s on land no more significant than two hectares and the property’s primary use isn’t for domestic or private purposes.
Step 3: Understand the Property Asset Rules
When purchasing commercial property via an LRBA, it must be a single acquirable asset (or a set of identical assets with the same market value).
Properties spanning multiple titles (like a commercial space with a separate title for a car park) need individual bare trusts for each title if they’re independently saleable.
ATO guidelines also restrict any alterations that fundamentally change the property’s nature until the loan is repaid. Thus, significant renovations aren’t allowed but cosmetic improvements can be allowed. Any property improvements must be funded by the SMSF, not through borrowed finances. Getting written advice from a Perth SMSF tax accountant prior to undertaking your renovations (or even buying the property) is important.
Step 4: Establish a Bare Trust
If your SMSF borrows money to finance the purchase you must create a bare trust for an SMSF loan acquisition, designating the SMSF as its beneficiary. This trust serves as the property’s registered holder for the SMSF until the loan is fully repaid.
The trustee of the SMSF mustn’t be identical to the trustee of the bare trust. Also, some lenders mandate a corporate trustee for the bare trust.
If the SMSF has cash to pay the property in full, you will enjoy significantly less cost to acquire the commercial property in your SMSF.
Step 5: Assess Fees and Costs
Buying commercial property incurs various expenses, including upfront and legal fees, advisory costs, stamp duty, property management fees, banking and loan charges, and ongoing expenses like strata and property management.
Commercial property LRBA lending criteria are typically more stringent than standard loans, often requiring higher loan-to-value ratios. Lenders may limit lending to 55%–80% of the purchase price, necessitating substantial SMSF funds for the property deposit.
It’s advisable to compare different SMSF loan interest rates and terms, as they can differ significantly.
Important: Some lenders reduce loan amounts for SMSFs with individual trustees instead of corporate trustees and may even demand corporate trustees for both the SMSF and bare trust.
Step 6: Draft a Sale Contract
When purchasing a commercial property, the contract should state that the buyer is the bare trust’s trustee. Typically, the contract must list both the bare trust and SMSF. This issue is important later when the commercial property loan is repaid, and you want to close the bare trust and transfer legal title to the SMSF trustee without paying stamp duty. So getting help from your Perth SMSF tax accountant and your lawyer about the purchase and stamp duty aspects in front is important.
The bare trust’s trustee must be the registered owner at settlement and be named on the title certificate. Incorrectly naming the buyer could lead to costly stamp duty issues.
Important: LRBA borrowed funds cannot be used to refinance or enhance existing super fund properties, only to acquire new assets.
Step 7: Apply for a Loan
SMSF loans require detailed documentation and thorough lender assessment, potentially prolonging the process.
Lenders usually ask for the trust deeds of both the SMSF and bare trust, SMSF tax returns, rental income evidence, and the sale contract.
Lenders may also review fund members’ financial status or require income proof of future super contributions are necessary for loan repayments. Further, lenders often require evidence that the SMSF is registered on the Super Fund Lookup website and despite the work from your Perth SMSF tax accountant, can take a long time to process by the ATO.
Important: Many lenders insist on personal guarantees for LRBA loans, as the loan’s non-recourse nature limits asset recovery options. In case of property sale and incomplete loan repayment, lenders might target your assets if a personal guarantee is included.
Step 8: Finalize the Property Purchase
Before finalising the sale, seek legal, tax and accounting advice to avoid potential stamp duty issues related to the document signing order.
As the legal purchaser, the bare trust’s trustee should sign the contract and be recorded as the owner on the title deed.
Step 9: Arrange a Commercial Lease
If your business intends to lease the property, establish a registered commercial lease to demonstrate an ‘arm’s length’ relationship to the ATO between your company and the property owner (the bare trust).
The lease should reflect market rent and typical commercial terms. Non-commercial lease terms might result in the SMSF’s income (including capital gains) being taxed at 47% as non-arm’s length income (NALI).
Rent should be paid regularly and on time, mirroring a typical landlord-tenant relationship.
If lease income doesn’t cover the LRBA loan repayments, the SMSF must compensate with super contributions.
Step 10: Arrange insurance
The property should have insurance like any other ordinary property. And if you have arranged for additional debt within your SMSF you might want to consider if your life insurance needs have changed. So, talking to a registered insurance broker to review your new insurance needs is essential.
Step 11: Arrange SMSF software
If your Perth SMSF Tax accountant is on the front foot you will have a wrap account that manages the commercial property investment management, tax reporting and audit reporting obligations. This will often be coupled with a cloud accounting platform that integrates the bank statements to reduce on your SMSF compliance obligations.
What are the advantages of buying your commercial property in your SMSF?
- Control over rental income
A significant risk of investing into commercial property is the risk of your tenant not paying the rent. If you are your own tenant you significantly reduce the risk of not getting paid.
- Tax Efficiency
Investing in commercial property through an SMSF can be tax-efficient. Rental income received by the SMSF is taxed at a concessional rate, which is normally 15%, but can reduce to zero when the fund is in pension mode. This rate is usually lower than tax rates for companies or individual family members. Capital gains on properties held for more than 12 months also receive a one-third discount for tax purposes, making it an attractive long-term investment.
Further, as real estate is a tax advantageous investment you will also enjoy these tax benefits in addition to the SMSF structure.
- Asset Protection
Properties held within an SMSF enjoy a level of asset protection. In the event of bankruptcy or other financial difficulties, assets within an SMSF are generally protected from creditors, offering a secure investment environment.
- Potential for Personal Use
An often-overlooked advantage of SMSF-owned commercial properties is the ability to lease the property to your business related to the SMSF members, under certain conditions. This can create a unique opportunity for business owners to pay rent to their SMSF, contributing to their retirement savings.
- Control Over Investments
SMSFs provide members with greater control over their investment choices. This means that SMSF trustees can make direct decisions about commercial property investment, including the type of property, its location, and the terms of the lease agreements.
- Long-Term Capital Growth
Commercial real estate often appreciates over the long term, offering the potential for capital growth. This appreciation in value can substantially increase the overall value of your retirement fund.
What are the disadvantages of purchasing a commercial property in an SMSF?
- Restricted business growth
If your business outgrows the property you can become conflicted as a landlord and as a business owner. Sometimes the best decision for the SMSF landlord is not the same as the best decision for the business.
- Better tax outcomes outside the SMSF
If you qualify for the small business capital gains tax concessions, you might also be able to sell your commercial property later and enjoy the sale proceeds tax-free. You could also look at 50:50 Unit Trusts to purchase a commercial property as well.
- Restricted loan repayments
The ability to contribute money to your SMSF through concessional and non-concessional contributions is restricted through the Tax Act. Excess concessional and non-concessional contribution tax can occur, so the tax strategy of an SMSF and the loan strategy can potentially conflict.
If your fund suffers the new $3m super tax the ability to contribute additional monies to your SMSF might become even worse.
- Negative gearing
If your commercial property incurs a net tax loss within a SMSF the tax losses are trapped within a SMSF. If the property is in a different tax structure you could possibly have strategies to recoup these tax losses against business income.
Further, if you can offset the tax losses from your negatively geared commercial properties inside your SMSF against SMSF income the tax benefit is less. The SMSF income that you are offsetting might suffer a tax rate of zero or 15% compared to company and individual tax rates.
- Loan refinance
If you want to use the equity in your commercial property later to refinance other loans you cannot do that. The equity in the commercial property is locked and protected from other creditors.
- Increased costs
Operating a commercial property in an SMSF has a higher cost structure compared to a trust, company, or personal purchase. These costs become even higher if the SMSF trustees make one of the 7 common SMSF mistakes.
- Reduced investment options
If you invest your money into a commercial property, you have less assets to invest elsewhere (like the stock market). So, talking to a licensed investment advisor about forecast returns beyond that you can generate from your commercial property is important. If you can generate investment returns that are double or triple what you could enjoy your commercial property purchase, then buying a commercial property in your SMSF and leasing it to yourself is a poor decision.
How to start buying a commercial property
If you are serious about purchasing a commercial property, farm, factory or office for your business an SMSF is always one of the tax structures to consider. However, it is not the only way to structure a property purchase and is not the only way to buy a property. Talking to an independent firm of tax accountants like Westcourt is important. We do not have competing interests like promoting ASX stocks and we have proven tax leadership within SMSF and we work only with families in business. If you consider our unique market position together with our deep global tax network in GGI we are the natural choice for SMSF property advice – so why not give us a call?