SMSFs and 13.22C trusts - an alternative approach to co-owning property

Stephen Miller from MLC Technical Services explains how establishing a 13.22C trust can enable SMSF trustees to co-own a residential or business property with a related party.

Sometimes trustees of a self-managed super fund (SMSF) want to co-own a residential or business real property with a related party, such as an SMSF fund member or family member.

A niche strategy that may offer greater flexibility and ease of administration in certain circumstances is to:

• Establish an ungeared trust that conforms with Superannuation Industry Supervision (SIS) regulation 13.22C, known as a 13.22C trust;
• Subscribe to the trust by purchasing units in the trust; and
• Use the trust’s money to acquire the residential or business real property.

13.22C requirements

To meet the requirements of SIS regulation 13.22C, the trust must:

• Be a unit trust;
• Have no debt and not allow any security to be taken over its assets;
• Have no lease arrangement with a related party other than one relating to business real property;
• Not acquire an asset (other than business real property) from a related party;
• Not lend money to any entity other than an authorised deposit taking institution (eg, a bank);
• Not conduct a business; and
• Not own an interest in another entity – which means it cannot own shares or invest in another trust.

Broadly, this means the trust will only own residential or business real property and cash on deposit.

Key benefits

A key benefit of using this strategy is that the SMSF can take a part-interest in a property and share in the returns from that investment without being directly exposed to the business or other risks associated with the related party.

It’s also possible for the related party to borrow money to fund the acquisition of units in the trust, thereby enabling them to indirectly gear their ‘share’ of the underlying asset.

This means the related party should be able to claim the interest on the loan as a tax deduction if the trust assets are income-producing.

Example: Establishing a 13.22C trust

Richard runs a successful small business, and has the opportunity to acquire the property from which he conducts his business for $1 million.

While most of Richard’s capital is tied up in his business and he only has a small super balance, he owns an unencumbered residential property.

Richard’s parents have an SMSF and are willing to co-invest in the property – provided they receive a commercial return and are not liable for any of Richard’s debts.

Richard’s financial adviser helps them establish an arrangement whereby:

• A trust is established that complies with SIS reg 13.22C;
• Richard’s parents’ SMSF subscribes to units in the trust to the value of $550,000;
• Richard borrows $550,000 against his residential property and uses this money to subscribe for units in the trust;
• The trust uses the $1.1m in cash to acquire the property, pay for certain ancillary expenses and provide the trust with some liquidity by holding the surplus cash in a bank account, and
• The trust receives the rental income, pays the relevant outgoings, and distributes the net income to the unit holders (ie, Richard and his parents’ SMSF).

This strategy will allow Richard’s parents to invest in a property that is not directly exposed to Richard’s business, and will provide their SMSF with a share of the returns from the investment.

Richard, on the other hand, will be able to acquire an interest in a property he wouldn’t be able to purchase in his own right. He should also be able to claim the interest on the loan used to subscribe for trust units as a tax deduction.

Ongoing flexibility

Because a 13.22C trust is not an in-house asset, an SMSF may acquire units from a related party over time. This gives the SMSF the flexibility to increase its interest in the investment by either subscribing to new units in the trust or purchasing units from the related party or other unit holder.

The related party could subscribe to more units in the trust personally, or they could set up their own SMSF and acquire trust units in their SMSF.

These outcomes could be achieved by acquiring units from the SMSF involved in establishing the 13.22C trust – either while these SMSF trustees are alive or when they pass away.

If the related party acquires units in their own SMSF, they could use the money received personally to reduce any debt used to establish the arrangement and have their interest in the net rental income from the property flow to their SMSF where less tax may be payable.

One or both parties could subscribe to new units in the trust to inject more capital and fund improvements to the property, which would potentially increase the rental income.

Also, if the related party runs a business and takes on a new business partner, the new partner could share in the ownership of the property by acquiring units in the trust.

Key considerations

Some of the transactions outlined above could have capital gains tax (CGT) implications and may be subject to duty as the trust would be a ‘land rich entity’ under the various state Duty Acts. 

However, with careful planning, these outcomes may not arise in some circumstances. For example:

• Units disposed of from an SMSF during pension phase would generally be CGT-free;
• The related party may be able to utilise the small business CGT concessions when disposing of units in the trust; and
• The Duty Acts typically offer concessions in some circumstances where there are transactions between an SMSF and its members.

Also, a holding in a 13.22C trust that is not owned by an SMSF may be offered as security for a loan. If this is done, the interest would potentially be available to the owner’s creditors.

SMSF trustees who co-invest in such a trust need to consider the risks involved, which could be considerable if the SMSF is a minority unit holder and the trust came to be directly controlled by creditors.

The trustee of the unit trust would need to conduct its affairs on a purely arm’s length basis to avoid any SIS compliance problems for the SMSF investors.

Bottom line

While using a 13.22C trust to facilitate the co-ownership of a business or residential property can offer a number of benefits for investors in certain circumstances, it is not a strategy that will have wide reaching applications.

There are other ownership options available, and it is essential that SMSF trustees seek legal, accounting and financial planning advice before implementing such arrangements.

Stephen Miller is a senior technical consultant with MLC Technical Services.