What are your options with purchasing a property with your SMSF?
With the legislative restrictions and lack of competitive lenders, a limited recourse borrowing arrangement (LRBA) may not be the answer to all SMSF client prayers when looking to purchase larger assets in their SMSF. If you’re an SMSF Trustee, this may leave you wondering what your options are when looking at purchasing a property in your SMSF?
One other method is with a 13.22C Unit Trust commonly called a Non-geared Unit Trust (NGUT).
In this article we discuss The Good and The Bad points of these arrangements, and if things go wrong The Ugly consequences.
A 13.22C Unit Trust allows a SMSF the option to co-invest in a property purchase with other related parties, which they normally would not be able to do. This allows the Fund to participate in larger property purchases due to the cash injection from other sources – personal wealth, personal borrowings, business partners etc.
They are not restricted in what you can do with their property in terms of improvements, sub-dividing etc. and therefore offer more flexibility than a LRBA.
They also have no restriction over the member’s personally borrowing to purchase units in the unit trust which may be easier and more commercial than via a LRBA.
Additional units can be issued to new or existing unit holders to fund improvements or developments & the SMSF can acquire units in the unit trust from a related party allowing to over time the transfer of the balance of ownership into the SMSF, reducing personal tax.
Example – Investment Property
Jack and Jill understand bricks and mortar, they like residential property and have developed an investment strategy that is property focused. However the downside is that they don’t have significant enough assets in their personal names or SMSF to fund a property purchase without borrowing. Jack and Jill considered borrowing but it is their plan to remain debt-free.
Jack and Jill’s SMSF has $400,000 and personally they have $200,000 to invest.
A 13.22C unit trust is established and their SMSF purchases $400,000 of units and they, personally, purchase $200,000 of units which leaves the unit trust with $600,000 in cash and the super fund owning 66.67% and Jack & Jill owning 33.33% of the units in the unit trust respectively.
The unit trust then uses this money to purchase the property, pay for all purchase costs and maintains some extra funds in a bank account for future expenses.
The unit trust manages the property – enters into the leases with tenants, receives the rent and pays the expenses such as rates, water, body corp, insurance and repairs. Given the property is residential, it cannot be leased to a related party.
The net profit is then distributed to the unit holders annually based on their ownership. Therefore the SMSF would receive 66.67% of the net rent and Jack & Jill would receive 33.33%. The SMSF and Jack & Jill would include their share of the profit in their tax return.
Example – Business Partners and Commercial Property
Hansel and Gretel are business partners in a business, Gingerbread Homes Pty Ltd, which makes pre-fabricated homes.
Gingerbread Homes have outgrown the current premises they were renting and as such Hansel and Gretel have decided to buy a commercial property.
Hansel’s SMSF and Gretel’s SMSF both purchase $300,000 units each in the newly established 13.22C Unit Trust. The Unit Trust again acquires the property and leases the property at market rates to Gingerbread Homes Pty Ltd, a related party.
Again, the net profit is distributed to each SMSF annually based on the unit holder’s proportion of ownership.
The SMSF’s now have an interest in a commercial property earning market returns with a secure long term tenant & Gingerbread Homes have the space they need and confidence in their landlord.
Two other interesting possibilities of a commercial property:
- Hansel and Gretel already owned the property personally and for estate planning, administration and tax planning decided to sell the property; at market price, into the protected low tax environment of super via the trust. Stamp duty would need to be considered in this strategy.
- Hansel and Gretel’s SMSF don’t have sufficient capital to purchase a commercial property large enough. They could borrow personally or contribute surplus personal cash to buy units in the Trust in their own names.
A 13.22 Unit Trust has its own set of rules that must be complied with at all times as the consequences are ugly – see below.
The bad thing about a 13.22C Unit Trust is that it is designed to only do one thing – hold the property, process the properties income and expenses, and distribute any profit to its unit holders.
It is not designed to accumulate cash and invest in other ventures, it is not designed to loan money versus distributing it. It is not a creative accounting loophole that gives the SMSF early access to its assets.
The SIS Regulations 1994 – Reg 13.22C states that a SMSF can only invest in a unit trust that meets the following conditions.
The unit trust cannot:
- Borrow (Non-geared Unit Trust);
- Lease to a related party, unless the asset is business real property (Commercial Property);
- Invest in another entity (Cannot purchase shares in a company, BHP etc.)
- Lend money, unless the loan is a deposit with an authorised deposit-taking institution within the meaning of the Banking Act 1959 (meaning an Australian bank account only);
- Have an asset that has a charge over it (No unit trust assets can have a mortgage over it);
- Acquire an asset from a related party of the superannuation fund after 11 August 1999, unless the asset was business real property acquired at market value;
- Hold an asset that has at any time been an asset (unless it was business real property acquired at market value) of a related party of the superannuation fund since the later of:
- The end of 11 August 1999; and
- The day 3 years before the day on which the SMSF first acquired an interest in the unit trust.
If there is a breach in the 13.22C regulations, section 13.22D takes over and says the whole arrangement is tainted, there are no possible rectifications & you can’t fix it. This most likely means the whole arrangement has to be unwound, which is complicated & expensive – especially when residential or a commercial property is concerned.
Therefore if you have a 13.22C Unit Trust – please get quality advice from your Accountant before you make any transactions within your 13.22C Unit Trust.