In Australia, property investment holds a significant appeal, notably due to the attractive 15% preferential tax rate on income during the accumulation phase and the potential for tax exemption during retirement. This has led many SMSF trustees to consider property development as a lucrative avenue for substantial returns. We will explore the advantages, disadvantages, and common issues that arise in this context.

An SMSF can invest in property development, provided the trustees ensure compliance with the regulatory framework. The regulations are comprehensive, with a critical aspect being the sole purpose test. Trustees must maintain the fund with the primary goal of providing retirement benefits and in cases of ill health or death. Violations of this principle carry severe implications, including the forfeiture of the fund’s concessional tax status and the imposition of civil and criminal penalties.

Given the inherently high-risk nature of property development, trustees must exercise caution to prevent the SMSF from becoming a speculative venture, especially when developments involve related parties.

There are several methods through which an SMSF can engage in property development, contingent upon the fund’s investment strategy permitting such activities:

  • Direct property development
  • Investment through an ungeared unit trust or company (including with related parties)
  • Investment in an unrelated entity
  • Participation in a joint venture

Direct Property Development from Fund Assets

An SMSF may acquire land from an unrelated party and undertake property development independently. Common challenges encountered include:

  • Prohibitions against acquiring land from related parties unless it constitutes business real property exclusively used in a business, thereby precluding the purchase of land from family trusts or inherited by members.
  • Restrictions on borrowing for property development, with SMSFs unable to utilise loans for property improvements and required to retain the original asset nature until any loans are fully repaid.
  • The necessity of engaging property developers at arm’s length, mainly when dealing with related parties, and ensuring transactions reflect market value without preferential treatment.
  • The potential applicability of GST on the development and sale of the property is subject to ATO’s consideration of the SMSF’s development activities as constituting a property development business or a commercial one-off project.

For SMSFs not directly undertaking property development, investment can be channelled through various structures:

Utilisation of an ungeared company or trust is common under SIS Regulation section 13.22C for related parties interested in property development investment. This structure mandates compliance with several conditions, including avoiding related party leases (unless pertaining to business real property), the absence of borrowings, non-engagement in business activities, and arm’s length transactions.

Unrelated Property Developments

Investments in unrelated entities offer an alternative free from ownership percentage constraints inherent to ungeared entities. However, it is essential to ensure that such investments do not exceed the SMSF and related parties’ ownership beyond 50% to maintain the status of an unrelated entity.

Joint Venture Arrangements

SMSFs may also consider joint venture arrangements for property development, necessitating careful evaluation of the arrangement’s structure to ensure compliance and avoid classification as an in-house asset.

Before embarking on property development through an SMSF, trustees must thoroughly assess the investment decision and ensure it aligns with a well-justified investment rationale. It is imperative to seek comprehensive advice from licensed financial advisers, legal professionals, and qualified accountants to navigate the complexities of property development investments within the SMSF framework.

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