Can my SMSF invest in property development?
Doing a property development with superannuation funds sounds appealing to many because Australians love property and love paying less tax.
An SMSF can invest in property development if the investment complies with the superannuation rules of which there is many. A key rule is the sole purpose test. The trustees of the SMSF (You and potentially other family members) need to ensure the fund is maintained to provide benefits for retirement, ill health or death. Breaches of this are serious and include the loss of the fund’s concessional tax treatment and/or civil and criminal penalties.
An SMSF can invest in property development if the investment strategy of the fund allows:
- Directly developing property
- An ungeared unit trust or company (the parties can be related)
- Investment in an unrelated entity
- A joint venture
- Directly developing property from fund assets
An SMSF can purchase land from an unrelated party and develop the property in its own right.
Common issues that often arise include:
- Acquiring the land from a related party – An SMSF cannot purchase land from a related party (unless it is business real property used wholly and exclusively in a business). This means that the block of land you own, or owned by a family trust, that is perfect for development cannot be purchased by the SMSF.
- An SMSF cannot borrow to develop property – An SMSF can borrow money to purchase land using a limited recourse borrowing arrangement but it cannot use a loan to improve the asset. That is, borrowings cannot be used to develop the land. And, where the SMSF has borrowed to purchase land, it cannot change the nature of that asset until the loan has been repaid.
- Who will develop the property? – Problems often occur when the property developers are related to the fund members. Whilst it is possible to engage a related party builder to undertake the work, there are strict rules that mean that the work and materials must be acquired at market value. No “mates rates”.
- GST might apply – Goods and services tax might apply to the development and the sale of any developed property. If the ATO considers that an SMSF is in the business of developing property or is undertaking a one-off development in a commercial manner then GST could potentially apply.
- Related ungeared trust or company
An ungeared company or trust can be used when related parties want to invest in a property development together. The SMSF can invest in a company or trust that is undertaking a property development as long as the company or trust:
- Does not lease to a related party (unless business real property)
- Does not borrow money or have borrowings
- Does not conduct a business
- Conducts any dealings at arm’s length
- The assets of the unit trust or company:
- Do not have shares in a company
- Do not have a mortgage over any asset
- Are not purchased from a related party (or was ever an asset of a related party) unless the asset is business real property acquired at market rates.
Profits from the company or trust are then distributed to the SMSF according to its share.
The SMSF can invest in property development with a related party without the development being considered an in-house asset only if all the above criteria is met and continues to be met throughout the development.
Problems can arise where the trust or company:
- Needs more money to complete the development and borrows money, or issues more units and sells them
- Accepts a loan from a member of the SMSF
- Overdrafts
- Uses a related party builder who either under charges for the work completed or overcharges and strips the profits that should have been returned to the SMSF.
Note: the trust or company cannot be conducting a business. This requirement may prevent short-term property developments that are built and sold for profit.
Typically, this structure is used for long term investments where the development enables the creation of an asset that is then leased by the trust or company.
- Unrelated property developments
Investing in unrelated entities for a property development is attractive as there is no limit to how much of the fund’s assets can be invested (subject to the investment strategy and trust deed allowing the investment), and the entity is able to borrow money.
Where related parties are investing in the same entity, the SMSF and their related parties must not own more than 50% of the units available. This is because the SMSF cannot control the entity and remain an unrelated entity.
- Joint venture arrangements
An SMSF can potentially invest in a joint venture (JV) property development, but the criteria are necessarily strict and there are a range of issues that need to be considered carefully.
Under a JV, the SMSF invests in and has a share of the property being developed (not the entity undertaking the development). Each party bears the costs of the JV and receives this same proportionate contribution from the returns. If the arrangement is not structured properly then the SMSF’s stake in the JV could be treated as an investment in or loan to a related party and be treated as an in-house asset.
It is also necessary to consider whether the arrangement between the parties could be treated as a partnership for tax, GST and legal purposes.
It’s essential to get advice well in advance – tax, legal and financial – before pursui
