Structuring your property development within your SMSF

Assuming that all the regulatory requirements can be satisfied, it may be possible for your SMSF to be undertaking activities in a number of ways, including:

  • As sole owner of the project, using SMSF funds
  • By a limited recourse borrowing arrangement
  • JV or as tenants in common
  • By investing via unit trusts.

All of these options have their own pros and cons, and your particular circumstances and financial goals will need to be carefully considered when deciding which is right for you.

Sole owner

Simply put, this is where you use the cash funds within your SMSF to acquire and/or develop land. This option may be suitable where you have the required funds to complete the acquisition and/or development without the need to borrow.

It has the benefit of resulting in 100 per cent ownership of the developed property in the name of your SMSF. However, the constraints are that you may not be able to acquire and/or develop the size of project that will derive the greatest benefit.

Starting small and diversifying within your SMSF portfolio is a positive strategy.

Limited Recourse Borrowing Arrangement (LRBA)

Under an LRBA, your SMSF will have the potential to acquire land/property that might otherwise be out of your reach with the ability to borrow.

The restriction is that you will not be permitted to develop that land/property until such time as there is no borrowing attached to the asset. Therefore, this strategy is a longer-term option.

Keep in mind that, because your superannuation is meant for retirement, a long-term option can be a very successful strategy.

JV or Tenants in Common

In a JV arrangement, your SMSF will partner with other/s to acquire and/or develop property. Like the LRBA option, this will potentially provide the ability to access larger scale development opportunities with a capital injection from your JV partners.

Ensuring that all activities are conducted at an arm’s length it could provide a successful result, particularly with the right JV partners involved in the development.

Dealing with a JV partner may present some issues, not unlike dealing with any business partner, and as such greater importance in this structure is placed on developing a clear plan and strategy for the development from the outset.

Unit Trusts

Unit trusts, be they related or un-related trusts, are another option for investing your SMSF funds.

Related unit trusts

A related party is either a close family member, a partner in a partnership, and a company or a trust that is controlled or significantly influenced by a member of the SMSF.

A related unit trust is a trust where an SMSF member and/or his or her associates either hold more than 50 per cent equity, exercises significant influence in relation to the trust, or can appoint or remove the trustee.

In summary, a related trust is where there are related parties involved.

Legislation allows your SMSF to invest in a related unit trust provided that, at the time the interest is acquired, the unit trust does not have any:

  • Interests in other entities
  • Outstanding borrowings
  • Charges over its assets
  • Loans to other entities
  • Leases with SMSF related parties (except in relation to properties used solely within a business)
  • Assets acquired from related parties (unless they are business properties or the assets were acquired by the unit trust more than three years before the SMSF acquired the interest in the trust).

The investment cannot amount to more than five per cent of your SMSF’s total assets. For example, if the SMSF has a total asset value of $1,000,000, they cannot invest more than $50,000 in a related trust.

Given the five per cent rule and the inability of the related unit trust to borrow, charge its assets or carry on a business, the SMSF may be limited in the context of property development activities. These restrictions do not apply to SMSF investments in unrelated entities.

Unrelated unit trust

An unrelated trust is one where there is no connection between the members of the SMSF and the trustees of the unit trust.

Investment in this type of entity is popular from a property development point of view when you want to share in the potential significant gains of property development without having to be involved with the development itself.

It has the added benefit of providing you access to much larger developments with greater returns than you would potentially be able to, given your balance within your own SMSF.

Subject to satisfying all the superannuation industry supervision (SIS) regulations and having a prudent investment strategy, your SMSF can invest in unrelated entities, including those that hold property, borrow money and carry out property development activities.

The threshold requirement is that the unit trust is unrelated to the SMSF for SIS purposes.  This means that a member of the SMF cannot control the trust either by entitlement to 50 per cent or more of the income or capital of the trust, or have the power to appoint or remove the trustee.

An unrelated trust structure could possibly involve two unrelated SMSFs each with 50 per cent of the units, 50 per cent of the shares and 50 per cent of director voting power in the trustee company.

Assuming that the ATO (or a court) can be satisfied that you have an unrelated trust (and there are no other areas of SIS risk), and investing in the trust is prudent and fits within the SMSF investment strategy, then this is a way for the SMSF to have involvement in property development.

The commercial and legal aspects of an investment of this type also need to be carefully considered, including:

  • The SMSF deed must permit the investment.
  • Fifty per cent control is not effective commercial control.
  • Unrelated investors may have different views about how things should work, and the terms of the arrangement should be carefully worked through and fully documented.
  • Lenders may need to be convinced that the structure doesn’t offend SIS rules.

There are no specific restrictions on the activities an unrelated trust can undertake, and there can be borrowings in an unrelated trust that undertakes property development activities.

Importantly, a unit trust in which one or more superannuation funds hold entitlements to more than twenty per cent of income and capital and which carries on a business (other than investment) is treated as a Public Trading Trust and taxed as a company, so that distributions are taxed as franked dividends.

Finally, if the ATO considers that income derived from unit trust holdings is not arm’s length, the income in question can be taxed at the top marginal tax rate. This could occur where units are issued below market value, or other income is injected into the unit trust, and ends up in the hands of the SMSF unit holder.

You can see by the above options that you need to carefully consider all of them and which would best suit your particular circumstances and longer term goals.

We would be happy to discuss these options with you to ensure you’re on the right track. Give us a call or send through an email and we’ll organise to meet and chat about your goals.

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Tony Dimitriadis
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