Holding property in SMSFs
Auditors are the mid-point between a self-managed super fund (SMSF) and the Australian Taxation Office (ATO) and therefore have a statutory responsibility to determine whether the fund has met the superannuation standards in the Superannuation Industry (Supervision) Act 1993 (SIS Act).
A fund that owns residential or commercial property should put in place procedures and supporting documents that the fund complies with the legislation.
Here are some things auditors may be interested in:
1. WHO OWNS THE PROPERTY?
An auditor will review who actually owns the property and usually undertake a real property search. Property owned by an SMSF is registered in the name(s) of the individual trustee(s) or corporate trustee but not in the name of the fund. When the property is settled, a declaration of trust should be made that the trustees are the legal owners of the property and hold it on trust for the SMSF.
If a portion of the property is owned with another party, the auditor will take an interest in the part owned by the fund, the capacity in which it is owned and whether the property has been mortgaged or encumbered.
If the property has been mortgaged, the fund may breach the rule which prevents the trustee placing a charge over a fund asset. However, the property can be mortgaged where the fund has a limited recourse borrowing in place.
2. ARE PROPERTY LEASE DOCUMENTS UP TO DATE?
If the property is leased, the auditor will be looking for current leases and property valuations. This applies especially with related party leases so they are made on an arm’s length basis. Otherwise, the income can be taxed at 45% as non-arm’s length income.
Rent adjustments must be up to date and consistent with market rentals. Where the rent is in arrears the fund should seek recovery of outstanding amounts. A number of legal cases have required the trustee to act in accordance with the lease agreement and take action to recover outstanding payments, irrespective of whether the tenant is a related party or at arm’s length.
For the 2019/20 and 2020/21 financial years, the auditor may also consider any concessions offered to tenants such as rent waivers or relief due to the economic impact of COVID-19.
3. WHAT ARE THE IMPACTS OF RENT RELIEF?
Due to the COVID-19 pandemic, many related and unrelated tenants have sought rental relief from the fund as landlord. The ATO is taking a reasonable approach to the
SMSF’s compliance, but in support of the SMSF offering rent relief the auditor will be looking out for:
- How the tenant is affected – did the business close its doors by direction/lack of business/loss of revenue/lack of supplies etc?
- Financial implication to the business – such as cashflow implications;
- The type of relief offered - discounts/rent-free period/deferrals that were considered by the trustee;
- The agreed review period – for example, two or three months or longer providing it is not a blanket rent-free period; and
- Impact period – leases were not impacted by COVID-19 until late February/March 2020, the auditor will consider whether rent has been paid under the lease from July 2019 – February 2020.
4. LOAN PAYMENT RELIEF TERMS?
An SMSF may also offer loan repayment relief for a loan made to a related or unrelated party who has been financially impacted by COVID-19. This may also apply where the fund has borrowed from a bank, other financial institution or related party for purposes of a limited recourse borrowing arrangement (LRBA).
The auditor could be expected to review the loan documents to see that the terms can be varied as agreed between the SMSF as lender and the borrower. The agreement may allow a reduction in the interest rate or repayments or a deferral of the repayments including the accrual of interest.
If the fund has borrowed from a bank or other financial institution, the auditor may review the terms of any loan repayment relief being offered to the SMSF. As a general rule, any relief should be consistent with equivalent arm’s length arrangements, especially those being offered by the big banks.
If the relief is on an arm’s length basis, the auditor may comment on the possible breach of Section 109. In some situations the fund may then face issues with the non-arm’s length income rules.
As a guide for loan relief, the Australian Banking Association (ABA) recommends that commercial lenders may provide loan repayment relief where:
- Interest and principal repayments on the loan can be suspended for up to six months;
- Interest continues to accrue on the loan during the deferral period;
- Accrued interest is to be capitalised and form part of the amount to be repaid over the term of the loan;
- The borrower must have been financially impacted by COVID-19; and
- The borrower must not terminate a lease or evict a tenant for rent in arrears during the loan deferral period.
The fund’s auditor, as well as the ATO, would usually accept a loan repayment relief arrangement where the trustee can provide evidence the relief is similar or identical to what is offered by for real estate investment loans at the time. The relief should be documented, accepted by the parties and prove the terms are on an arm’s length basis.
If an auditor considers loan relief has not been provided on an arm’s length basis, any material breach may be reported to the ATO by lodging an Audit Contravention Report.
The report will explain why the loan does not meet the arm’s length requirements in the current economic circumstances.
5. DOES THE PROPERTY REQUIRE A FORMAL VALUATION?
Real estate investments are not easy to value as there is no true market value until the property is actually bought and sold. But when the accounts of the fund are being prepared or benefits are paid from the fund, a reasonably accurate value of the property is required. Property valuations may be required for SIS Act for in-house asset purposes and to establish the transaction is made on an arm’s length basis.
The ATO says it does not require an external valuation each and every year. A recent valuation is prudent if the previous value is considered to be materially inaccurate or the value has changed due to changes in market conditions, a natural disaster or capital improvements. The current economic situation with COVID-19 is certainly one of those situations.
The valuation of a property, for SMSF purposes, does not require a formal assessment which can turn out to be expensive. Anyone may undertake the valuation as long as it is based on objective and supportable data. This can include a valuation from a property or online real estate valuation service or real estate agent. These valuations are usually provided at a minimal cost or free of charge.
A formal assessment by a qualified valuer may be required where the property is a significant proportion of the fund, has special features or the valuation is complex.
When valuing real estate, the assessment should consider:
- The value of similar properties in the area;
- The amount that was paid for the property in an arm's length market;
- Independent appraisals;
- Whether the property has undergone improvements since it was last valued; and
- For commercial properties, net income yields especially in the current economic situation are important as rent reductions for significant periods could impact the value of the property.
In contrast to the ATO guidelines, auditors are seeking greater confidence that the property value in the fund’s accounts satisfies the accounting standards. An auditor may require the trustee to obtain a more recent valuation rather than one that merely satisfies the ATO requirements.
6. PRIVATE COMPANY AND UNIT TRUST INVESTMENTS HOLDING PROPERTY?
The valuation of the private company shares or units in a private unit trust that have invested in property will vary depending on the underlying assets. A company or unit trust that owns commercial or residential property would have shares or units based on the value of the underlying property and potential income. In contrast, if the company or trust operated a business, the value would take any mid- to long-term change in turnover and profit.
The value of an investment may be difficult to determine based on asset values and turnover. The auditor is usually after a reasonable value based on recent sales of shares or units if they are available. This may require contacting the company secretary or trustee of the SMSF to obtain an indicative valuation or copies of financial statements. If this is not available or unable to be determined, the accounts may be qualified and send an audit contravention report to the ATO if breaches of the SIS legislation have taken place.
LESSONS TO BE LEARNT
The lessons for a fund that owns property is to make sure the trustees and the tenants:
- Comply with any lease documents including rent increases;
- Keep documents of any transactions or changes to agreements; and
- Can show that any transactions are made on an arm’s length basis.
Graeme Colley is executive manager, SMSF technical and private wealth at SuperConcepts.
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