By Monica Rule

Many Self Managed Superannuation Fund (SMSF) investors borrow money to purchase properties for their SMSF. Superannuation rules are complex and care needs to be taken when considering making alterations on a property owned by an SMSF.

Take a situation where an SMSF acquired a residential property via a limited recourse borrowing arrangement (LRBA). Soon after the acquisition, the local council rezoned the property to “mixed” use. Due to the rezoning, the SMSF member decides to lease the property from his SMSF to conduct his business. 

However, prior to the member moving into the property, the property needs some alteration work to comply with council regulations. A toilet in the property needs to be upgraded so it is functional and easily accessible for a disabled person. Therefore, the existing fittings must be removed and replaced with compliant fittings. An additional parking space is also required on the property.

Prior to doing the alterations, questions that must be considered by the SMSF trustee in order to comply with various provisions of the superannuation law are:

Would the alterations change the character of the property?

Under the borrowing rules, the SMSF is prohibited from borrowing to improve the property. However, improvements can be made using the SMSF’s own money, as long as it does not alter the character of the property to such an extent that the property becomes a different asset.

The property acquired by the SMSF was originally a residential property and was zoned residential. Therefore, the alterations to comply with the council regulations for business use will change the character of the property from residential to commercial and will change the character of the property. However, if the lease agreement entered into between the related party tenant and the SMSF trustee contains “retention of ownership” and “make good” clauses, the alterations will not change the character of the property. These clauses require that at the end of the tenancy, the tenant must remove all added fixtures so the property is left in much the same state as it was on entry. As the alterations remain with the tenant, it would not result in a different asset being held under the borrowing provision.

Would the alterations paid for by the tenant amount to an acquisition of materials by the SMSF from the related party?

Normally an object affixed to a property will form part of the property and will constitute an acquisition of that object by the SMSF trustee. However, if the lease agreement contains “retention of ownership” and “make good” clauses, any items that the tenant affixes to the property remain the sole property of the tenant and the tenant must remove these items upon the expiry of the lease. The tenant needs to ensure that the property is left in the same condition as the property was provided at the end of the lease term with fair wear and tear excepted. Provided this is done, the alternations made and paid for by the tenant will not be treated as an acquisition of assets or material by the SMSF trustee.

Would the alterations paid for by the tenant amount to contributions being made to the SMSF?

It is stated in Tax Ruling 2010/1, that a contribution is anything of value that increases the capital of a superannuation fund, provided by a person whose purpose is to benefit one or more particular members of the fund or all of the members in general.

If the “retention of ownership” and “make good” clauses exist in the lease agreement and the alterations are required to be removed upon the termination of the lease, the alterations will not amount to contributions being made to the SMSF. This is because the capital of the SMSF is not increased by the alterations as the tenant retains ownership of these.

Also, if the member performs any work on the property owned by his SMSF (e.g. painting or renovating), he can only be paid for the work performed if he provides the same service to the general public via his own business. If the member decides not to charge his SMSF for any work performed, then the increase in the value of the SMSF’s property would be treated as a contribution to the SMSF.

It is important that SMSF members do not try and draw up lease agreements themselves or perform any work on properties themselves. I would recommend employing a professional to draw up lease agreements where things such as “retention of ownership” and “make good” clauses are stated clearly in the lease agreement. It is also best to employ an arm’s length builder and contractors to perform alterations work on SMSF properties.

Gold and Platinum Members, please read on where Monica addresses the following questions:

• Can the SMSF sell the property before the building is returned to its original character, without incurring a penalty from the ATO?
• Would the SMSF be in breach if the property is sold before the building is returned to its original state?

Monica Rule is the author of “SMSFs and Properties” – www.monicarule.com.au

Disclaimer: The content of this Bulletin is general information only. It is not legal advice. The statements and opinions are the expression of the author, not Law Central, and have not been checked for their accuracy, completeness or changes in the law. Law Central recommends you seek professional advice before taking any action based on the content of this Bulletin.

Related Documents:

• Commercial Lease
• Self Managed Superannuation Fund Deed
• SMSF - Deed Update
• Acknowledegment of Trust
• SMSF Limited Recourse Borrowing Arrangement

Related Webinars:

• Webinar Recording - SMSFs and Related Party Loans
• Webinar Recording - Investment Restrictions for Self Managed Superannuation Funds
• Webinar Recording - Pitfalls that SMSF Trustees should avoid