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SMSF will acquire a property, via standard REIQ residential property contract, from a 3rd party (from an unrelated party)
The property is currently zoned residential but the Council advise a home office can be run out of the property.
SMSF will put in place a compliant LRBA arrangement, using a bare trust, with a 3rd party lender as part of the financing for the property’s acquisition.
SMSF intends to continue the residential letting as the primary use but continue the home office arrangement for use by one of the member’s business use (medical practice consulting room - psychotherapy).
While the SMSF has borrowings in place for this property, substantial changes cannot be made to the property (in a physical sense or in terms of how it is used).
While there are borrowings in place, the property cannot be converted wholly to commercial use, some residential use would need to be maintained (once the borrowings are fully paid out, then there would be no use limitations in this way).
Minor repairs and alterations are fine as they won’t change the essential character of the property , some of those minor alterations are potentially tenant fit-out costs.
SMSF (or the new bare trust) can lease commercial space to a member provide that space is used wholly and exclusively in a business – that lease will constitute “business real property”.
However, the whole property cannot be leased to a member and then sub-leased to any residential tenants (that lease would then not meet the definition of business real property”) – this will be the case irrespective of whether there are borrowings for this property or not.
There should be separate leases for the commercial space used by the member and any residential tenants.
Member could have a head lease for all the commercial use of the property and could then sub-lease to other commercial tenants (but not to any residential tenants).
Leases to any commercial tenants should make it clear that they continue to own their fit-outs and are responsible for making good their tenancy on completion or termination of their lease.
All transactions should be at market value and supported by documentation evidencing that market value (e.g., market rent appraisals).
Is there any Issues in above arrangements.
Hi Umesh
Yes I do not see any issues with what you have raised above.
The rules re SMSF's & property improvements are complicated where there is a LRBA in place.
The ATO advises that:
"Under subparagraph 67A(1)(a)(i) of the Superannuation Industry (Supervision) Act 1993 (SISA), borrowings under an LRBA cannot be used to fund improvements. Money from other sources can be used to improve (or repair or maintain) a single acquirable asset. However, any improvements must not result in the acquirable asset becoming a different asset.
There are significant changes to the nature and use of the property, and fundamentally, the property has become a different asset."
A great reference is SMSF 2021/1 "Self Managed Superannuation Funds: limited recourse borrowing arrangements - application of key concepts" & it can be found at:
https://www.ato.gov.au/law/view/document?Docid=SFR/SMSFR20121/NAT/ATO/00001
In relation to the business real property requirements a great reference is SMSF 2009/1 "Self Managed Superannuation Funds: business real property for the purposes of the Superannuation Industry (Supervision) Act 1993" & it can be found at:
https://www.ato.gov.au/law/view/document?Docid=SFR/SMSFR20091/NAT/ATO/00001&PiT=99991231235958
At paragraph 20 it states:
"Condition 2: connection between property use and a business
20. Once it is established that the relevant entity holds an eligible interest in the real property, that interest can only be business real property if the underlying land satisfies the business use test in the definition. The business use test requires the real property be used wholly and exclusively in one or more businesses , whether or not that business or those businesses are carried on by the relevant entity.
21. The character of the real property's use determines whether the business use test is satisfied. This will depend on questions of fact and degree. A holistic assessment of all facts and circumstances relating to the use of the property is made when working out whether the test is satisfied."
Thanks
SMSF AAA