Taking advantage of exceptions in the property rules

The facts

Generally, an SMSF cannot purchase a residential property from a related party – unless it meets the definition of ‘business real property’ (BRP), and there are only a few particular instances where this can occur.

Residential property and the BRP exemption

The definition of residential property for many includes property in an area zoned and used for dwellings such as houses, flats and apartments – all common investments for SMSFs.

Many consider BRP to include property zoned and used as office buildings, shops and retail premises to name a few – all common investments for small businesses, predominantly in an SMSF. There are always exceptions to the rule, however, and a residential property may also be classified as BRP.

Property development meets the business real property exemption

Many SMSF members who are also property developers ask the question: how can I purchase a unit from my land development using my SMSF?

Firstly, we must consider the definition of a related party. A related party of a superannuation fund includes a member of the fund or “part 8 associate of” a member of the fund under Section 10 of the SIS Act 1993 in Appendix 1.

For example, if the member of the SMSF and the director of the property development company are the same person, they are a related party. To transact with a related party, the BRP definition must be met.

Generally, the trustee of an SMSF must not intentionally acquire a residential property from a related party of the fund under Section 66(1) of the Superannuation Industry (Supervision) Act 1993 (Superannuation Law). However, there are certain exceptions to this rule in limited circumstances where the residential property satisfies the BRP exemption.

BRP can also extend to carrying on a business of property development, such as developing a block of land and constructing multiple units or townhouses where the acquisition from the related party is made at arm’s length. Specific guidance is provided in SMSFR2009/1 under example 37.

Arm’s length transaction

To meet the definition of BRP, the arm’s length requirement must be met. This is covered in a number of sections of Superannuation Law. This includes section 65, which prohibits the use of fund resources to provide financial assistance to a member. Further, section 62(1) stipulates the sole purpose test and section 109 stipulates that the transaction must take place at arm’s length.

Therefore, the purchase price of the property should reflect a market value that can be supported by an independent appraisal.

Case study

Joe Cox is a property developer whose business is, solely and exclusively, the development of property. Joe is currently constructing a five-townhouse development in Melbourne.

Joe establishes an SMSF, is the sole member of the it and a director of the SMSF’s trustee. Joe’s SMSF would like to purchase a unit from Joe’s development.

The three main considerations to satisfy BRP definition are:

• Acquisition of asset from a related party to the fund
• Physical use of the property
• Arm’s length transaction

Acquisition from a related party and physical use of the property

Section 66(1) of Superannuation Law states the trustee of a superannuation fund must not intentionally acquire an asset from a related party of the fund. However, "there are certain exceptions to this and one of them is in subsection (2)(b), in that the asset is business real property of the related party acquired at market value".

In this case, Joe is transacting with a related party. However, the development business is currently physically using the land to develop and such use takes place in the context of a land development business. Development is done “wholly and exclusively”, and Joe will purchase the property off the plan. Based on the facts presented, the BRP definition will be met.

Arm’s length transaction

Joe will need to transact at arm’s length, which means the purchase must be at market value and be supported by an independent appraisal from a local property professional. This will include a comparison of recent sales in the area and market conditions. Joe will purchase at the price reflected in the independent appraisal.

Based on the facts above and the guidance in SMSFR2009/1 – the above transaction is likely to meet the definition of BRP.

It is imperative for the above analysis, in consideration of Superannuation Law, to take place before the contract of sale is signed.

Other considerations

Although SMSFR2009/1 provides significant detail, it is important to seek advice from an experienced legal or SMSF specialist before proceeding with a purchase from a related party. Documentation will be required on file to support the arm’s length requirement, including:

• Independent valuation
• Rental appraisal
• Legal advice
• Contract of sale
• Stamp duty

The above documents will be provided to the independent auditor or bank's solicitors in the event of SMSF borrowing.