When can residential property meet the definition of a business building?
An asset can be acquired from a member or a related party of an SMSF if the asset meets the definition of a business building as defined in article 66 of the Superannuation Industry Act (oversight) 1993. Article 66 defines a commercial building as a real or leasehold interest in property used entirely and exclusively in one or more businesses.
The definition does not mention whether the property is commercial or residential. The question to be asked is whether the asset is entirely and exclusively used in a business.
A residential building will meet the definition of a commercial building and, therefore, can be purchased from a related party by a fund when:
- The number of residential properties owned by the related party is such that the related party is considered to operate a business of managing a residential property portfolio.
- Residential property is used in the related party’s business, for example, an office or surgery in the case of a dentist, veterinarian or doctor.
- Residential property is the commercial stock of a business, for example, a developer.
We have outlined some of the factors you need to consider in determining whether a residential property is a commercial building.
The job of managing a rental property portfolio
Seven years ago, an Administrative Appeals Tribunal (AAT) found that an individual was “in the business” of operating a business managing rental properties, even though he had never made a profit.
The facts of this case (YPFD v Commission des ImpÃ´ts ) include:
- The taxpayer owned nine rental properties, which were managed on a part-time basis.
- The taxpayer was employed full time as a scientist, so he was not fully focused on the rental real estate industry.
- They spend considerable time managing the portfolio and managing the real estate agents who perform certain tasks related to the real estate portfolio.
- They didn’t have a business plan.
- They had never made a profit – but the Tribunal decided they intended to do so.
The issues that the AAT considered in determining that the taxpayer was operating a rental property management business were as follows:
- The intention to build the rental property pool and make a profit
- The repetition and regularity of the activities that the taxpayer has undertaken in the management of property
- The complexity of the heritage, the size of the business and the amount of capital invested
When all of the above factors were taken into account by the AAT, it was decided that a person could operate a rental property management business.
This position was reinforced by the Australian Taxation Office (ATO) decision on commercial real estate SMSFR 2009/1, which confirms in several examples that residential real estate can meet the definition of commercial real estate and , therefore, be acquired from an SMSF related party.
Residential real estate held in a real estate investment company – example 14 of SMSFR 2009/1
- Mr. Wood owns 20 residential units which are leased to long-term residents. Mr. Wood manages and maintains the apartments full time living off the income generated by the leases.
- The units are not mortgaged.
- Mr. Wood would like his SMSF to acquire some of the units rather than selling the units to an unrelated party.
- The scale of the transaction, as well as the repetition and purpose, indicate that Mr. Wood is in the real estate investment business.
- Even though tenants use the properties for their own private or household purposes, that use remains incidental and relevant to Mr. Wood’s real estate investment business. Therefore, Mr. Wood’s interest in the property on which the units are built is a business building. Provided that the acquisition takes place at market value, the units may be acquired by SMSF without contravening the rule of acquisition of assets from related parties in Article 66.
Residential property used in another business
Provided that the property is used entirely and exclusively in a business, it does not matter whether it is residential or commercial. Here are examples of properties used in this way:
- A residential property used as an office for a doctor’s office or practice
- A residential property used to operate a bed and breakfast business.
Again, SMSFR 2009/1 contains an example that demonstrates the ATO’s interpretation of this matter.
Medical practice in residential premises
- Dr Mary owns a house that is used exclusively by her doctor’s office.
- Dr Mary is a member of Yianni SMSF and in her capacity as SMSF trustee wishes to acquire the house at market value and then rent it out again so that the doctor’s office can continue to operate from the house.
- Although the house was built to be living quarters, it is not used as such.
- The building is used entirely and exclusively for the medical practice of Dr. Mary.
- For the purposes of the related party asset acquisition rule in section 66, the property is commercial real estate of Dr. Mary.
- Once acquired by Yianni SMSF, it is also a business building of the fund and therefore is not an internal asset of SMSF.
What would you like to know
Legislation allowing an SMSF to purchase commercial real estate was originally enacted to allow small businesses to keep their business premises in their superannuation fund. Given this concessional way in which assets are taxed when held by a superannuation fund, this can be a beneficial strategy for business owners to use when planning for retirement.
However, it is not always clear when a property will meet the definition of a business building, so if this is an area that interests you, please do not hesitate to contact us.
Mark Wilkinson, priveted heritage partner, BDO
Emma Ryan is Deputy Director of Content at Momentum Media and Editor-in-Chief of the company’s legal publication, Lawyers Weekly.
Emma has worked for Momentum Media since 2015 and has been tasked with publishing some of Australia’s biggest business stories. In addition, she produced exclusive multimedia and event content related to the company’s brands and respective audiences.
A journalist by training, Emma has spent her career connecting with major industry players on a variety of platforms, including online, podcast and radio. She graduated from Charles Sturt University with a BA in Communication (Journalism).