The real object of business real estate
The answer to the question of whether a property meets the actual purpose of a business building (BRP) is “it depends”. A full understanding of all the facts and circumstances is necessary to ensure that the property meets the BRP definition at the time of acquisition.
The importance of BRP comes from the fact that it is one of the few exempt assets under the s66 SIS acquired from a related party, which means that it will not become an internal asset of the fund.
However, all other requirements of the SIS legislation will apply, as the acquisition must:
- Be authorized by the trust deed.
- Meet the needs of the fund’s investment strategy.
- Be acquired at market value from independent appraisal prior to purchase.
- Have no loan or charge on the asset (unless obtained under a limited recourse borrowing agreement).
And to be clear, a residential unit on the Gold Coast where an SMSF trustee lives and operates an online business will not meet BRP’s definition.
Definition of BRP
BRP generally refers to land and buildings used entirely and exclusively in a business. There are two (2) necessary conditions that BRP must fulfill prior to acquisition:
- The SMSF or a related entity must have a qualifying interest in real estate.
- The underlying land must meet the criterion of commercial use, ie the property must be used entirely and exclusively in one or more businesses operated by an entity (see SMSFR 2009/1).
Also, keep in mind that a qualifying interest in BRP only includes freehold or leasehold interests or interests in Crown land that may be ceded or transferred.
The stake here is the land and the construction‘s current use, ie the review of operations, activities or actions enabling the application of the business use test.
For example, an owner of land can grant a lease on part of this land. In these circumstances, the lessee has a leasehold interest in the land and has a qualifying interest.
The “wholly and exclusively” threshold may still apply where there is a minor, insignificant or insignificant non-commercial use of the property. However, the property will fail the commercial use test if the land is inactive, dormant, or not in use.
Is a business operated?
The whole entity‘s the activities are relevant in determining whether they constitute an operating business, which includes:
- Keeping business records separate from personal records.
- The size of the operation and the scale of the capital investment involved.
- If activities are carried out on a continuous and systematic basis rather than on an ad hoc basis.
- Employee engagement.
- A goal and an intention to perform an activity.
- A level of repetition and regularity of the activities constituting the company.
- If the activities are carried out in the same way as other similar businesses.
- Whether the activities are planned, organized and carried out in a professional manner.
- The scale and permanence of operations.
- The existence of a business plan.
Therefore, it would be difficult to demonstrate that a building met the BRP definition when the business was only in operation shortly before SMSF acquired it.
It is easy to classify vacant land as BRP when a business uses the property. While construction of buildings or premises on the property is not necessary, the key is the use of the land.
A typical example is where a vacant lot used as a parking lot can be commercial real estate if it is operated as a business. In this case, allowing drivers (under contract license) to bring their vehicles to the lot to use the property enables the commercial use test to be applied.
Conversely, an unused vacant block classified as “trading stock” of a related entity would not be a compliant acquisition. Such a transaction would not comply with the exemptions described in s66 SIS, which only concerns the purchase of BRP or listed shares.
Is an accessory part of the property?
Whether a building or other fixtures constitute “immovable property” is subject to the degree of annexation test and the subject of the annexation test, which determines whether the building or accessory is attached to the land. in a way other than by its own weight.
If so, the building or facility is considered part of the land. Alternatively, if it is only attached to the land by its own weight, it is assumed that it is not part of the land.
Even when a building or an accessory is attached to the land, the object of the annexation test must be considered. The test is to determine if the object and purpose of the affix was for the device or the terrain‘s advantage.
When it has been affixed to the land for the benefit of the building or only temporarily, it is not an accessory and is not part of the land. As a facility is separate from the land, it cannot be a BRP and will not attract concessional treatment under the SIS.
Demountable buildings, for example, are not fixed devices and do not form part of “real property”.
On the other hand, a building may have been originally demountable but becomes a fixed element and is now part of the property. Indicators here include its attachment to permanent foundations and water and electricity connections.
Determining the actual purpose of the commercial use test requires questions of fact and degree in each case. The physical use of real estate property is essential to understanding SMSF compliance parameters.
It will be the responsibility of the SMSF trustee to demonstrate that the property undertakes operations, activities or actions allowing the application of the commercial use test.
The rule of thumb is that related party transactions are classified as high risk, so SMSF auditors will take a closer look at BRP during the audit.
More information provided by SMSF administrators in advance will result in fewer queries and a more efficient audit – a win-win for everyone.
Shelley Banton, educational manager, ASF Audits