It's common knowledge Australians have a love affair with property. What, with the potential for a 15% preferential tax rate on income during the accumulation phase... And potentially zero tax in retirement... It's not surprising that many SMSF trustees dream of large returns from property development investments. But with these investments come complexities that need careful navigation. Including considerations for tax, regulations, and ultimately ownership.
Can my SMSF invest in property development?
Absolutely, as long as you're fully compliant with the rules. So let's unpack some of the important elements to consider - and there's quite a few.
Firstly, the sole purpose test - the golden rule. Your fund must, at all times, be maintained to provide benefits for the retirement, ill health or death of the fund's beneficiaries. If you fail this test, your fund could lose its concessional tax treatment and you may be at risk of civil and criminal penalties. So, it's important to ensure that the property development investment is not just a means to finance a personal project.
Remember, property investments can be high risk, so your focus should not be solely on the potential returns. If your developers are related parties, for instance, complications could arise. Moreover, there's a host of issues that often pop up such as borrowing restrictions, GST application, and conflicts with related party builders.
Investing in property development comes with a variety of methods your SMSF can consider, such as directly developing the property, investment through an ungeared unit trust or company, investment in an unrelated entity, or even through a joint venture. We discuss the specifics of each investment route in our deep-dive blog here.
Directly developing property from fund assets
One exciting opportunity for an SMSF is the ability to acquire land from an unrelated party and embark on developing the property independently. However, this undertaking may come with its fair share of challenges. Some common issues that frequently arise include:
Restrictions on land purchase by SMSFs (acquiring the land from a related party) -
Self-Managed Super Funds (SMSFs) are restricted from buying land from parties related to them, except when the land classifies as business real property that's actively used in a business. So, if an SMSF member inherits a prime piece of land or it's owned within the family trust and seems ideal for development, the SMSF is barred from acquiring it.
Borrowing limitations for property development in SMSFs (cannot borrow to develop property –
While SMSFs have the privilege to take out a limited recourse borrowing arrangement to finance the acquisition of land, they are not permitted to leverage loans for property improvements or development. Essentially, any borrowed funds cannot be directed towards development activities, and the SMSF must fully repay the loan before considering any changes to the nature of the asset purchased.
Development complications involving related parties (who will develop the property?) -
Engaging with property developers who have personal ties to SMSF members can be fraught with complications. Although hiring a related party builder is not off the table, it's imperative to adhere to strict regulations ensuring all services and materials are procured at market value—this precludes any "friendship discounts." When working with a related builder, maintaining immaculate records, fair market transactions, and well-documented interactions is critical.
Potential GST implications on property transactions (GST might apply) -
The development and subsequent sale of properties by an SMSF might attract Goods and Services Tax (GST). The Australian Taxation Office (ATO) may impose GST if it deems the SMSF to be engaging in property development as a business activity, or even if there's a single instance of development conducted in a commercial manner.
If you want more information on mastering property investment with your SMSF, check out our comprehensive guide here.
Investment alternatives for SMSFs in property development projects
Should your SMSF choose not to directly embark on a property development project, it still has a couple options to participate in such ventures:
Investing through a related ungeared Trust or Company –
According to SIS Regulation, section 13.22C, an SMSF can place investments in an ungeared company or trust that is itself carrying out a property development, provided certain conditions are met by the company or trust:
- It must not rent out property to a related party, except if it's considered business real property.
- It cannot take on or presently have any debt obligations (it must be entirely ungeared).
- It should not engage in any business operations.
- All transactions must be conducted at an arm's length basis.
- Additionally, the assets of the trust or company must adhere to the following:
- They shouldn't represent an ownership interest in another body (i.e., holding shares in another company).
- There should be no charges, like mortgages, over any of the assets.
- The assets must not be acquired from a related party or previously belong to one, with the exception of business real property purchased at market value.
For comprehensive details, consult section 13.22C. Profits generated by the trust or company are proportionally distributed to the SMSF based on its unit share.
Utilising section 13.22C allows SMSFs to invest in property development with a related party without classifying the development as an "in-house asset". However, failure to comply with these criteria at any point could result in the application of in-house asset rules, potentially necessitating the disposal of units in the trust or company shares to remain within the permissible 5% in-house asset limit. This process may require selling the property or undertaking a significant restructuring.
Challenges with arrangements under section 13.22C can emerge if the trust or company:
- Requires additional capital for project completion and seeks funding through loans or the sale of new units (engaging in business).
- Accepts loans from an SMSF member.
- Experiences overdrafts, which could be seen as loan infringements against section 13.22C regulations.
- Engages with a related party builder who charges too little or too much, disrupting the proper return of profits to the SMSF.
Cautionary note on business operations:
One essential condition for exemption via section 13.22C is that neither the trust nor the company can conduct any business activity. This stipulation could exclude short-term property development initiatives intended for immediate profit through sales.
Section 13.22C setups are typically more suited for longer-term investment strategies. In these scenarios, the development leads to the creation of an asset that the trust or company then leases out. Possible examples include commercial spaces rented to related or unrelated businesses, like a child care center or a manufacturing site, or residential properties let out to third parties, such as townhouses or small housing projects.
When an SMSF explores the realm of property development, it may engage with unrelated entities to mitigate certain regulatory restrictions and to avail itself of greater investment flexibility. The following points summarize key considerations for SMSFs when investing in property developments through unrelated entities or joint ventures:
Investing in unrelated entities
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 unlike ungeared entities, the entity is able to borrow money/place charge over the assets.
Where related parties are investing in the same entity, there are rules governing the percentage of ownership the SMSF and their related parties can hold. To meet the definition of unrelated entity for in-house asset purposes, the SMSF and their related parties must not own more than 50% of the units available. This is because the SMSF cannot control or hold sufficient influence over the entity and remain an unrelated entity. If the ATO considers the entity is related to the SMSF, then it would become a related party and the investment an in-house asset.
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. One of the issues that needs to be considered up-front is determining the substance of the arrangement between the parties, because the term JV can be used to describe a variety of arrangements. The ATO confirms that care must be taken to ensure that arrangements with related parties are true JVs.
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 (time and/or money) 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. For example, this could be the case if the SMSF only provides a capital outlay for the arrangement and has no rights other than a contractual right to a return on the final investment.
It is also necessary to consider whether the arrangement between the parties could be treated as a partnership for tax, GST and legal purposes. For example, this could be the case if the arrangement involves the sharing of income, sale proceeds or profits, rather than sharing the output from the project.
It's essential to get advice well in advance - tax, legal and financial - before pursuing a JV.
Is your SMSF the best vehicle for property development?
So, is your SMSF the ideal vehicle for your property development aspirations? The answer depends upon your unique circumstances and investment strategy. Embarking on this journey demands expert advice, a reliable team, and a shared focus on financial success and happiness.
Any advice on a property development needs to be from a licenced financial adviser. We urge you to enlist the guidance of a qualified financial adviser, a solicitor for contracts, and an accountant for compliance as you navigate the property development landscape with your SMSF. Trust in their expertise and safeguard your investment against the pitfalls of the complex world of property development.
Important Disclaimer
HT Ventures Pty Ltd T/AS Trekk Advisory is a Corporate Authorised Representative (No. 1245336) of GPS Wealth Ltd | ABN 17 005 482 726 | AFSL 254 544 | Australian Credit Licence 254 544 | HT Ventures Ltd ABN 26 604 443 763
The information contained in this article has been provided as general advice only. The contents have been prepared without taking account of your objectives, financial situation or needs. You should, before you make any decision regarding any information, strategies or products mentioned on this website, consult your own financial advisor to consider whether that is appropriate having regard to your own objectives, financial situation and needs.
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