Is it possible for my Self-Managed Superannuation Fund (SMSF) to engage in property development?
Explore the possibility of property development for your self-managed superannuation fund (SMSF). Bates Cosgrave offers expert guidance.
The allure of property investment is strong for Australians, fueled by the potential for a 15% preferential tax rate on income during the accumulation phase and potentially no tax during retirement. Many SMSF trustees are drawn to the idea of substantial returns from property development.
An SMSF can participate in property development, provided that trustees adhere to the established rules—of which there are many. The sole purpose test is a crucial criterion, requiring trustees to ensure that the fund is maintained to provide retirement, ill-health, or death benefits. Breaches of this fundamental tenet could result in serious consequences, including the loss of concessional tax treatment and civil and criminal penalties.
Given the inherently high-risk nature of property development, fund trustees must ensure that the SMSF isn’t merely a convenient source of funds for a speculative venture, especially when related parties are involved. There are various avenues for SMSFs to invest in property development, depending on the fund’s investment strategy:
- Direct property development
- Investment in an ungeared unit trust or company (even with related parties)
- Investment in an unrelated entity
- Participation in a joint venture
If the SMSF intends to undertake property development directly, several challenges and considerations arise:
- Acquisition of land from a related party is prohibited unless it’s business real property used exclusively in a business.
- SMSFs cannot borrow to develop property; borrowing is allowed only for land acquisition through a limited recourse borrowing arrangement.
- Selection of property developers, especially related parties, requires adherence to strict rules, ensuring fair transactions at market value.
Additional complexities may arise, such as the potential application of Goods and Services Tax (GST) to the development and property sale.
For SMSFs not directly engaging in property development, alternative investment approaches include:
- Investing in a related ungeared trust or company, following specific regulations.
- Investing in unrelated entities for property development, subject to the investment strategy and trust deed.
- Exploring joint venture arrangements, which have stringent criteria and require careful consideration to avoid in-house asset classification.
The exemption under section 13.22C allows SMSFs to invest with related parties without it being considered an in-house asset, provided specific criteria are met. Issues may arise if the entity involved needs additional funds, accepts loans from SMSF members, overdrafts, or utilizes related party builders inappropriately.
Trustees must exercise caution when determining whether a trust or company is conducting a business, as this could impact the applicability of the exemption.
Joint venture arrangements for property development within an SMSF are possible but entail strict criteria and careful consideration of the arrangement’s nature. It is crucial to obtain expert advice—tax, legal, and financial—well in advance of pursuing a joint venture.
Ultimately, SMSF trustees must carefully weigh the suitability of their fund for property development and seek advice from licensed financial advisers, lawyers for contractual matters, and compliance assistance from qualified accountants before proceeding with any property developments.
If you have any questions regarding SMSF, give us a call on (02) 9957 4033.