It is a known fact that Australians have a keen interest in property investment. One of the main reasons for this is the 15% preferential tax rate on income during the accumulation phase, which can potentially mean no tax during retirement. Due to this, many trustees of self-managed super funds (SMSFs) are lured into dreaming of high returns from property development. However, several pros, cons, and potential problems need to be considered before investing in property development through an SMSF.
The answer to the question ‘Can I use my SMSF for property development?’ is ‘YES’, but you need to do it very carefully. An SMSF can invest to develop a property if trustees ensure the investment is compliant with the rules. And, there are several rules and regulations. Trustees have to ensure that the fund can offer benefits for retirement, death or ill health. There are serious breaches of this tenet and include civil and criminal penalties and loss of fund’s concessional tax treatment. There are various ways an SMSF can invest in property development if the fund’s investment strategy allows:
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Directly Developing Property from Fund Assets
An SMSF can buy land from an unrelated party and develop the property. The following are some common problems that often arise:
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Obtaining the land from a related party
An SMSF can’t buy land from a related party unless it is business real property used fully and exclusively in a business.
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An SMSF can’t borrow for property development
An SMSF can borrow to buy land using a limited recourse borrowing arrangement but it can’t use a loan to improve the asset. And, where the SMSF has borrowed to buy the land, it can’t change the nature of that asset until the loan has been repaid.
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GST might apply
GST tax might apply to the development and sale of the developed property. If the ATO considers that an SMSF is in the business of property development, then GST could apply.
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Who can develop the property?
Issues often occur when the property developers are related to the members of the fund. While it is possible to involve a related party builder to undertake the work, there are some strict rules, which means that materials and work must be obtained at market value. In case, you use a related party builder, then make sure that the paperwork is perfect and all interactions are documented.
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An Ungeared Trust or Company
An ungeared trust or company is used when related parties want to invest in developing a property together. The SMSF can invest in a trust or company that is undertaking property development as long as the trust or company:
- doesn’t lease to a related party
- doesn’t borrow money
- doesn’t run a business
- conducts any dealings at arm’s length
- the asset of the trust or company:
- don’t include an interest in another entity
- don’t have a charge over them
- are not bought from a related party unless the asset is business real property obtained at market value.
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Investment in an Unrelated Entity
Investing in unrelated entities for the development of property is alluring as there is no limit to how much of the fund’s assets can be invested. For unrelated entities for in-house asset purposes, the SMSF and their related parties must not have above 50% of the units available.
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A Joint Venture
An SMSF can invest in a joint venture property development, but the rules are strict and various issues need to be considered. Under a joint venture, the SMSF invests in and has a property’s share that is being developed. Each party bears the expense of the JV and gets this same proportionate contribution from the returns. Additionally, it must be considered whether the arrangement between the parties can be considered a partnership for GST, tax, and legal purposes.
Is Your SMSF the Best for Property Development?
Trustees have to be very careful while making any investment decision. Any suggestion on a property development must be taken from a licensed financial adviser. A lawyer must be hired for any contracts between parties. Additionally, compliance assistance from a reliable accountant.
Contractor or Employee?
The Australian Taxation Office (ATO) has issued new guidance warning that just because a worker is identified as an independent contractor in a written agreement, it does not necessarily mean that they are considered as such for tax and superannuation purposes.
The rights and obligations of the contract must support the existence of an independent contracting relationship. Merely having an Australian Business Number (ABN) does not necessarily indicate genuine engagement as a contractor. The ATO says that the fundamental difference between an employee and an independent contractor is that an employee works for an employer as part of that employer’s business, whereas an independent contractor provides services to a principal’s business while pursuing their own business enterprise. They perform the work as the principal of their own business and not as part of another business.