SMSF financing display home

Hi all,

Seeking some clarification regarding a SMSF investing in/financing the purchase of land and construction of a couple of display homes. The potential issue is that the director of the building company doing the construction is the spouse of a member of the SMSF. His business will do a leaseback of the properties as display homes (standard type of rate for this type of rental) for 2 years after which the SMSF is free to sale or rent out the homes (to non-related parties).

I've read about issues under the SIS act with spouses of members but curious whether this would constitute the same type of issue. I'm not sure whether using a property as a display home constitutes a commercial property (no-one would be living at the home). I'll be seeking legal (and taxation) advice but wanted to see whether anyone here had any initial guidance.

Thanks

 

Breach of sis act

 

Display homes comes up a bit in families who own building companies. Its not as prohibited as most think. But some technical issues do need advice to ensure compliance :

Typically the SMSF will construct the build OR acquire it and both require very different approaches. Care must be taken that a contribution or breach of sole purpose test occurs. The tax ruling on contributions provides some general guidance. All must be arms length. Its a area where prior vetting by the SMSF auditor will help avoid issues later.

SMSF loan is a harder option but not incapable of use since the property can be structured as business real property at the time of acquisition meaning its not prohibited but will come with come restrictions. BRP tests require that the property must be USED in this capacity before acquisition. Many exhibition home sites have restrictive land covenants which help this. Care has to be taken outside established ex village sites. And then there is a need to demonstrate arms length pricing. Some issues to address including use of going concern basis perhaps OR margin scheme OR general GST issues as well as a correct lease to Buildco. And finally the lease needs to be correctly implemented. Typical lease returns on these properties span 3-5 years and offer generous returns plus good "make good" clauses at termination.

Ungeared unit trust is also a possible option. Or widely held trusts in some cases.

 

Thanks for the feedback everyone. We would be avoiding the issues relating to borrowing as the investment would be entirely cash funded. Contracts for the land purchases have already been signed by the building company with "or nominee" (this is in Vic). These contracts are with the estate developer.

I've started reading the relevant sections of the SIS Act as well as ATO determinations. I'm better versed in Pensions as we have never owned property directly in the super fund previously. There are 3 members in the fund (one in pension phase) and we would be paying all rents into a joint account in the funds name.

I'll be contacting our super adviser this afternoon to get their opinion as well about whether this is a breach of the SIS Act. I'll update if anyone is interested.

Thanks

 

Have you sought legal advice?

 

Hi Terry,

Not as yet. We will before going ahead.

 

Seems like contracts have already been entered into.

 

The contracts are between the director of the building company (he's the spouse of a member of the fund) and the estate developer. At this stage we are reviewing the potential to purchase the display homes through the SMSF instead (purchaser on contract is listed as building company or nominee).

The director of the building company got legal advice on the original contract. He'll just get financing from the bank if it's not possible for the SMSF to purchase. He's built a dozen or so display homes previously so this isn't new ground for him at least.

 

well get legal advice before nominating a SMSF trustee or Custodian trustee. Best to avoid nomination for a variety of reasons.

 

The pension issue may create a risk for the fund. Also how to deal with death benefits risks for the other two members. If it isnt addressed a death could force the sale of the exhibition home. Issues that have to be addressed include arms length pricing and lease matters as well as a issue with acquiring the ex home for under cost which could be a form of contribution affecting caps and compliance.

The breach issues arent in the issue of s66 and what we normally think of as prohibited investments since its very likely permitted to be acquired but that needs legal advice to determine what is actually be acquired and how. Its far too simple to consider that s66 doesnt apply so that means it is permitted. Its more than just land. Is there a contract for a build too ? Profit shifting between the building co and the SMSF would need more diligence than a normal SMSF purchase to avoid serious tax issues later. ie selling construction at a discount to the SMSF could trigger non-arms length income tax concerns and see the fund non-compliant.

If cash is being used an ungeared unit trust may also offer more flexibility especially to address death issues one day (ie a new investor who is NOT a member, a second SMSF etc) perhaps even a investor now who wants to neg gear their share (without breach of SIS) . However the contract entered into now and a nominee that is a trustee and trust that doesnt exist may complicate the stamp duty problem . If thats the case, complying with all the relevant provisions is SIS Reg 13.22 C and D and financial advice and legal advice would be best before going ahead.

 

The lender might not accept a contract where the SMSF is not explicity named as the purchaser. They are pretty fussy about detail with SMSF purchases.

 

If the asset will be acquired with borrowed money, it should probably be the custodian that enters contracts.

There is also the issue of if the nomination from a related company to the SMSF trustee is this an 'acquisition'. Possibly not, but it muddies the waters.

 

One of the major law firms that vets SMSF loan docs for many lenders does have a issue with nomination contracts. They have a concern it can breach s66. And the broader concern in s66(3) regarding persons who may not be associates of the members but who are still indirectly "connected with a member" can also occur. ie business associates.

A nomination is a form of transfer / sale - Just not subject to duty. SISA doesnt care for the duty exemption but does contain a prohibition on acquiring an interest from a related party / associate.

A Reg 13.22 acquisition does not require such a diligent exploration other than a prohibited acquisition (firstly as no lender vets the docs and secondly as there is no loan) and applies a lesser test of being acquired by a trustee and excludes the asset from the tougher inhouse asset rules eg s66(3) especially where the property is used as real business property.

 

Indeed.

My post was intended to point out that the actual purchaser (associated with) the SMSF should be on the contract, rather than nominated as purchaser on a nomination form after the fact

 

Thanks for the input everyone. There will be no lending in our situation which removes many of the issues. Another one to watch out for is SMSFR 2010/1, but that can apparently be handled using a deed of agency agreement. Lawyer is looking into everything now to cross t's and dot i's.