Team-playing: Issues when an SMSF owns only part of a property
Joining with others to buy real estate can have powerful advantages for investors. Elizabeth Wang reviews the main issues trustees should consider when their super fund holds or acquires less than the whole interest in a property.
John and Mary have decided to enter into a contact of sale to acquire a one-half interest in a residential property in NSW under a limited recourse borrowing arrangement. The result of the purchase of the property is that it will be co-owned with another SMSF, who will own the remaining half interest in the property.
Issue 1: The purchase contract
The contract of sale must show the purchase of the half interest in the property by John and Mary’s SMSF. John and Mary will also need to ensure that the contract has provisions which stipulate that after settlement the property will be held by the two SMSFs as tenants in common (as opposed to joint tenants) so that the property does not pass to the other owner/s automatically on the death of either John or Mary or both. Their SMSF must have a divisible share in the property.
Issue 2: Co-ownership
As the property will be co-owned issues may arise in relation to the decision-making and day to day management of the property. That is why a formal agreement between the two SMSF owners is necessary. Without such an agreement there is no certainty as to:
• the apportionment of expenses and income;
• insurance for the property; and
• the first right of refusal in the event that a party wishes to sell their interest.
Such an agreement not only facilitates administration of the investment but also assists any necessary compliance with s109 of the SIS Act (relating to transactions which involve related parties and which therefore must be transacted commercially).
Issue 3: No cross-collateralisation
John and Mary will also need to ensure that the mortgage over their half interest in the property is completely separate and distinct from any other mortgage which may be granted over the remainder of the property so that neither owner is providing security for the other.
This means that if either John and Mary or the trustees of the other SMSF default the mortgagee will only have access to the portion of the property which secures the loan to the defaulting party and not to any other interest in the property. This will make obtaining finance more difficult but not impossible. It must be discussed with prospective lenders early in the application process.
Issue 4: The in-house asset rule
In-house assets are a loan to, or investment in, a related party, an investment in a related trust, or an asset of your fund that is leased to a ‘related party’, such as John and Mary’s relatives or companies or trusts controlled or majority-owned by John, Mary and or their associates.
The property half owned by each fund would not be an in-house asset of either fund though it would not be permissible for either fund to lease the asset to a related party of either.
If the two SMSFs decided to invest indirectly by buying units in a trust that owned the real estate, that trust could be an in-house asset of any SMSF which effectively controlled the trust. The fact that the two SMSFs are themselves related could mean that the trust is controlled by the entire group of related parties which could mean that direct investment in the real estate would be preferable to investment indirectly via a trust which could be an ‘related trust’ and therefore an in-house asset.
At Townsends Business & Corporate Lawyers we can assist with preparing the relevant documentation should you wish to use your SMSF to acquire less than the whole interest in a property. For further information, please contact Townsends Business & Corporate Lawyers on (02) 8296 6222 or email email@example.com to see how we can assist.