Many would say that the trustee of an SMSF is prohibited from ever acquiring residential property from related parties of the SMSF (including members). However, there are three main circumstances where this could happen without contravening superannuation law. All of the circumstances involve the concept of ‘business real property’.
Business real property
Broadly, SMSF trustees are prohibited from acquiring any assets from related parties, unless those assets fall within one of the specified exceptions. One of the exceptions is if the asset is business real property, and is acquired at market value. The question is then whether residential property can ever fit this definition.
The law defines business real property as an interest in real property, where that real property is used wholly and exclusively in one or more businesses (regardless of who carries on that business or those businesses).
There are three main ways that residential property can be business real property.
Residential land held as part of a land developer’s business
Firstly, it is possible to carry on a business of property development. Indeed, the ATO has expressed concern in TA 2014/1 about property development receipts that are business income (ie, ordinary income), but have been declared as capital gains. The question is, what facts need to be present to make this work?
In example 37 of SMSFR 2009/1, the ATO give the example of a property developer (Trevor) who is in the business of ‘purchasing land for development, obtaining council approvals, hiring contractors, building, selling’. If such a business is on foot, the ATO confirm that one of his properties used in this way qualifies as business real property. What is more, the ATO state that such a property will qualify after the construction and development is complete, while the development is in progress, and even if it is acquired off the plan before any activity occurs on the land. It appears that the crux of this reasoning is, if the property is Trevor’s trading stock, it will be business real property.
One factor that can make this scenario more difficult is when the person holding the property has not been declaring business income, but for superannuation law purposes would like to assert they are carrying on a property development business so that the properties can be business real property.
Residential land used in the business of renting properties
To reiterate, business real property is real property used wholly and exclusively in one or more businesses. The word ‘used’ is a broad term, and the ATO view is that it is possible for residential use to be inherently in connection with a business. In particular, if there is a genuine business of renting out properties (the ATO call this a ‘property investment business’), the residential use of those properties has a relevant connection with a business. One would ordinarily expect a business of renting out properties to have some scale before it can truly be considered a business. However, in reality the analysis is tricky.
The ATO give two examples in their ruling. In the first example, Mr Wood owns 20 residential units that are leased to long-term residents. Mr Wood manages the units on a full-time basis and lives on the income generated. The ATO say Mr Wood is carrying on a business, and that his SMSF can acquire one of the units from himself (a related party) at market value. On the other hand, in example 15, Ms Harrington owns 10 residential units and uses an agent to manage them. The ATO suggest that the use of the agent means Ms Harrington does not carry on a property investment business. However, a 2014 Administrative Appeals Tribunal decision suggests that even nine rental properties can give rise to a business of renting our properties, even though an agent was used. Accordingly, 20 properties should not be considered a ‘magic number’. Whether or not there is a business unfortunately cannot be answered with a simple checklist. The individual circumstances of each case have to be weighed up.
Short term accommodation
Lastly, it can also be possible that short term residential accommodation can constitute business real property (and therefore can be acquired by an SMSF from a related party, provided the acquisition is at market value). The rules surrounding this are highly technical. In short, the ATO view is that if the owner of the real estate leases it to an entity that runs a business of providing short term of accommodation, and then the entity running the business grants rights to the guests, the real estate can be business real property. On the other hand, if the owner (who is not running a business) technically directly leases the real estate to the guests (using the assistance of an agent including a real estate agent) the real estate is not business real property.
Any residential property that qualifies as business real property must be acquired at market value by the trustee of the SMSF. While technically there is no requirement for the property to be valued by a qualified independent valuer, such a valuation is best practice and can assist to show how the market value of the property was arrived at.