Can your SMSF do a Property Development?
Can your SMSF do a Property Development?
Traditionally it is believed that your SMSF cannot engage in a business activity with your SMSF, including that of property development. In recent times, property development within an SMSF structure has become quite common, even so with related parties of the SMSF assist with the property development in some capacity or another.
Due to the strict rules that apply within an SMSF which includes specific investment related rules that prohibit or restrict transactions with related parties, careful consideration must be undertaken if an SMSF is involved in a property development with a related party.
The risk of the SMSF breaching the regulatory rules and regulations under the SIS Act can potentially increase if a related party is involved with a property development with an SMSF.
Although the possibility of undertaking a property development in a SMSF, primarily, the following key considerations must be considered and satisfied:
- The sole purpose test; and
- The involvement of related parties in a property development
Sole Purpose test
The SIS Act requires an SMSF to be in existence solely for the following purposes:
- at least one ‘core’ purpose, for example, to provide benefits to members of the SMSF for their retirement; or
- at least one ‘core’ purpose and at least one ‘ancillary’ purpose, for example, assuming a condition of employment release is satisfied, to provide benefits to members upon termination of their employment.
If an SMSF has been in existence for a purpose contrary to the sole test above, it will breach the sole purpose test. For example, an SMSF provides benefits to its members before their retirement whereby (as an example amongst many others) the members make use and enjoyment of a beach house that the SMSF owns, and/or any activity undertaken in the SMSF where the dominant purpose is to exploit and take advantage of the tax concessions available in an SMSF.
Therefore, if the sole purpose test is satisfied, then any activity (including property development) which is undertaken is fine. In addition, what is also required to satisfy the sole purpose test is what is described as ‘exclusivity of purpose’, which means that this is the highest standard than the maintenance of the SMSF for a dominant or principal purpose. The ATO has a ruling, SMSFR 2008/2, which is applicable to this. The SMSF Ruling explains that the Sole Purpose Test may still be satisfied even if benefits that are incidental, remote or insignificant have been created by a transaction or decision. Of course, this is only if those benefits are incidental to the fund being maintained with the section 62(1) purposes exclusively in the trustee’s mind.
The ATO has issued a document titled “Carrying on a business in a self-managed superannuation fund” whereby it states that there is nothing in the law which specifically prevents an SMSF from carrying on a business; however, this in itself does not necessarily mean that the SMSF does not satisfy the sole purpose test. The sole purpose test is not about whether or not the SMSF is operating a business; rather, it is the activities of the SMSF that are relevant.
In relation to a property development business undertaken in an SMSF, if this in itself is an isolated transaction or a business, then the ATO may review the activities in the SMSF because the more speculative activity undertaken by the SMSF is involved, then the likelihood of contravening the sole purpose test are high.
Involvement of related parties
With related parties being involved with the property development business within the SMSF, the ATO will also closely monitor the activities insofar as for example, whether the property development is an extension and/or a continuation of the related party’s property development business, whether or not transactions are below market value, favourable/uncommercial settlement terms and/or level of remuneration of family members but to name a few. These are the types of activities and transactions that the ATO will be reviewing to determine whether the property development satisfies the sole purpose test.
Additional requirements
Prior to undertaking a property development in an SMSF, the following legislative and regulatory requirements must also be considered and met:
- The SMSF’s Deed must allow for the SMSF to undertake a property development (the SMSF Deed can always be updated if there is no current provision in the existing SMSF Deed); and
- The investment strategy of the SMSF must allow for the property development to be undertaken; and
- There must be no borrowings whatsoever in the SMSF to undertake the property development.
Although caution is required, provided all the legislative and regulatory requirements are met and satisfied, property development in an SMSF is possible.
Angelo Panagopoulos
Principal
Ground Floor 40 River Boulevard, Richmond 3121 | PO Box 536, Hawthorn 3122
Tel +61 3 8419 9800
Email: angelop@wilsonpateras.com.au