As we noted in a recent blog post on property valuations for SMSFs, properties have become increasingly popular investments for self-managed super funds in recent years. However, there are several risks to be aware of when a trustee invests in either residential or commercial property, especially when it comes to renting out or leasing that property to another trustee or to a family member (in other words, a related party).

Here are some general guidelines, as well as situations that raise red flags for our auditing team – and by extension, the ATO.

Residential property rentals

When it comes to residential properties, neither a trustee nor any family members of trustees can live in a property owned as part of an SMSF. For example, a client can’t buy an apartment through their SMSF and then rent it out to their son, their second cousin twice removed, etc. The property also can’t be used as a part-time or holiday home for the trustee.

However, one case where this wouldn’t apply would be if an SMSF includes an active, working farm with a residential property on the land. If the farmer lives on the farm, that’s considered incidental to the main business of raising crops, animals, vines, etc., that take up most of the land and are the primary use of the property.

Therefore, it’s possible to purchase a farm as part of an SMSF and lease it back to the farmer – even if that farmer is the SMSF trustee or a relative – because in this case, the farm is considered business real property.

What is meant by business real property?

Business real property (BRP) generally refers to land and buildings used wholly and exclusively in a business or businesses. This could include an office, office building, warehouse, or a farm, as noted above. However, BRP cases must be carefully examined. According to the ATO, how a property is used determines whether it can be considered a BRP or not.

SMSFs, business real property and rentals

From an SMSF perspective, trustees can purchase a commercial property such as an office and lease or rent it to themselves, another trustee or to a family member for business use, as long as certain conditions are met, and the appropriate documentation is in place.

In these cases, what’s most important is that the SMSF trustee who owns and rents a BRP to a related party follows the same standards that they would in an arm’s length transaction: a standard rental arrangement in which the owner and renter act independently, where the two people don’t have a previous connection or family relationship.

For instance, let’s say your trustee has an office that he or she owns within an SMSF, and that trustee wants to rent it to a cousin who has a small business. This is allowable as long as:

  • At the commencement of the agreement, the trustee obtains an independent expert opinion of the market value of the rental;
  • There are clear, well-documented terms of the commercial agreement;
  • There is clear documentation of rental payments being made on time and at the agreed, fair market price; and
  • Variations in the agreement are justifiable and documented (for instance, during the COVID period when property owners adjusted rent due to unforeseeable circumstances).

Basically, our audit team and the ATO need to ensure that the trustee isn’t cutting Cousin Charlie an unfair deal – or being pressured to do so – just because he has a family connection.

Therefore, it’s important that in these types of rental situations, SMSF trustees have the proper documentation to avoid potential problems during an audit.

If you have questions about SMSFs and BRP rental arrangements, please contact our team at AYS.

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