Owning commercial space in an SMSF can make a lot of sense for both SMSFs and business owners. It can provide a steady source of income and capital growth for the SMSF, and also provides stability for the business owner rather than having a third-party landlord. At the same time, having the business premises in an SMSF, rather than holding it personally or in a partnership, can provide significant tax savings on disposal. Finally, SMSFs also provides one of the most robust structures for protecting assets from creditors in the event of bankruptcy.
How can the SMSF legally acquire business premises from business owners?
Unlike residential property, an SMSF can acquire “business property” from related parties without violating Section 66 of the SIS Act. The property must be business property used exclusively for business purposes (e.g., it cannot be a retail store with a residential building above). In addition, the acquisition must be at fair market value (i.e., independently appraised).
The sole purpose of the transaction must be to create a retirement asset for members (i.e., it must be consistent with the SMSF’s investment strategy). You should consult with your financial advisor, if necessary, to ensure that the transaction is a good fit with your portfolio.
Can the property be transferred free of charge?
Business property can also be contributed to an SMSF without cash (in-specie). The transfer is considered a contribution to SMSF members and is subject to the maximum contribution limits. The maximum amount for non-concessional personal contributions is $150,000 per year (depending on the member’s age and work status). However, non-concessional contributions of $50,000 for members over age 50 or $25,000 for members under age 50 may be made. Trusted Tax Accountants in Tarneit
Most SMSFs typically have two members (with a maximum of four members), and therefore most small businesses can contribute commercial property valued at less than $1 million without exceeding contribution limits and incurring excess tax. Care must be taken when making contributions in the two subsequent years if you take advantage of the “carry forward” provisions. A combination of cash and non-cash contributions may also be elected for the transfer of the property.
What about debt financing if the SMSF does not have sufficient funds to purchase outright?
Yes, this is possible, but it is important that the transaction is done in the proper manner and properly documented.
Business property can be purchased by the SMSF from a related party, provided an existing mortgage has been previously paid off. The existing indebtedness must be paid off prior to the transfer to the SMSF, and a new indebtedness arrangement can be made through a limited recourse loan agreement. It is critical that an independent appraisal be used to determine the purchase price.
Unlike ordinary borrowing, a limited recourse loan is taken out through a pure trust to legally invest the property in an SMSF. Generally, it is recommended that the amount of borrowing not exceed 60% of the property value. This is because the investment is generally cash flow positive and no additional funds are needed from outside the SMSF. If you default on repayment of these loans, your bank may require a personal guarantee and this payment would be considered a member contribution, which may result in excess tax if the contribution limits are exceeded.
Limited recourse borrowing can be an ideal opportunity to allow SMSF members to purchase a property they could not otherwise afford. To take advantage of these structures, it is important to seek tax and legal advice. Tax Return Agent in Melton
Commercial Lease Agreements
Once the property is located within the SMSF, a legally enforceable lease agreement must be executed between the SMSF trustee and the related party (Section 71 SIS). We recommend hiring an attorney to draft a commercial, fully documented lease agreement between the SMSF trustee and the entity. The agreement should state that the rent is to be paid at fair market value by the company to the SMSF and should also set out, for example, the consequences of not paying the rent on time. The rent should also be adjusted periodically in subsequent years to ensure that the rent paid always reflects the market value.
Capital gains tax
No capital gains tax may be payable on the sale or transfer of an existing property to the SMSF, depending on whether the business premises are used for the related parties’ business and whether they qualify for small business CGT benefits. Capital gains may also be reduced in certain circumstances by the member making a concessional contribution to the SMSF and claiming a deduction to offset the gain. Tax Agent in Craigieburn
Once SMSF members reach age 55, they can also draw an annuity (transitioning to a retirement income stream) and may not be subject to capital gains tax on the subsequent sale of the property. This is a major benefit for business taxpayers who do not qualify for the small business capital gains tax credit. Because the tax on the gain is not split between the years the property appreciates in value during the accumulation phase and the years during the retirement phase, capital gains from the sale of assets within the SMSF are tax-free once retirement has begun.
If the property is sold by the SMSF before the pension phase starts and the building has been held for more than 12 months, the tax on any capital gain in the SMSF will continue to be taxed at a reduced rate of only 10%.
In some states, stamp duty may also be payable when the property is transferred to the SMSF, depending on how the transaction is structured.
The rental income fewer expenses are taxed at 15 cents on the dollar in the SMSF. If the entity is a corporate taxpayer, rental expenses are taxed at 30%, saving the family a total of 15 cents on the dollar in taxes. This savings increases to 30 cents on the dollar when members enter the retirement phase. Tax Agent in Melbourne
Assets should also be valued on a reasonable basis each year in the SMSF. An annual independent valuation is not required, and a non-binding valuation by a real estate agent is usually sufficient. If the SMSF is in retirement mode, the property and SMSF assets must be valued at market value each year to continue to qualify for the generous tax benefits available to SMSFs in retirement mode. To continue to claim these benefits, a market valuation should be carried out by an official valuer every three years, with an on-site valuation in between. The value should always be compared to the Council Tax assessment. If the SMSF is not valued at market value, it may not qualify for pension benefits and all income will be taxed at 15%.
Including the property in an SMSF also provides an excellent barrier to asset protection because the property is not exposed to creditor risk and other inherent business risks. However, there are provisions in the Bankruptcy Act to recover contributions made to satisfy creditors. SMSFs are superior to both industrial and retail funds because only these funds can acquire assets. Although trustees are taking on more responsibility, they will continue to be the preferred structure for retirement savings. Trustees need to seek advice before making a final decision on a strategy to ensure that any pitfalls can be identified and precautions are taken. Accounting Consulting Firms in Australia