Avoid these joint property purchase problems

SMSF technical expert and columnist for The Australian newspaper
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There’s a lot of niggly bits to sort out when you decide to invest in property with another party, particularly if you’re using your self-managed super fund (SMSF).

Last week, I ran over the three options you have when purchasing a property as a joint venture: direct ownership; unit trust; and corporate ownership. This week, I’ll look at some of the operational issues that often arise.

Set the rules

Before the property purchase takes place, your DIY super fund and the other party must decide how they intend to jointly manage the investment. You need to establish:

  • Who will manage the property?
  • How will decisions regarding the property be decided?
  • Ideally, how long will the asset be owned?
  • How often will net income be paid to the owners and who will ensure this is administered effectively and appropriately?
  • How will disputes between the owners be settled?

Get it in writing

As trustee, you must ask the other party to declare, in writing, that it won’t act in any way that would cause your SMSF to lose its tax concessions or breach the super laws, which could also result in you being fined by the Australian Tax Office (ATO).

The other party must also be prepared, in limited circumstances, to sell the property if the super fund needs to access money. One example where such a need as this arises is if a fund member died and the SMSF needs to liquidate investments to pay a benefit.

It’s also important that your joint venture partner agrees not to use the property as security against any borrowing because this might cause the SMSF significant issues. If the property is held in a trust, then the other beneficiaries of the trust must make a similar declaration about their investment in the trust.

These issues are really important and should be agreed to in writing. Problems often arise because neither party has bothered to do any ‘what-if’ analysis about these and other issues prior to purchase.

Potential problems

Legal problems can arise if your super fund provides financial assistance, either directly or indirectly.

Financial assistance, such as a loan, can be a problem if the other party in the arrangement is a member or a relative of a member in your SMSF.

The ATO says they constantly see this type of breach of the super laws. I’m not surprised by this because I’m sure most people look at their super money as ‘their’ money – which it clearly is – so the inability to use it when needed doesn’t make a lot of sense to many people.

Financial assistance to fund members or their relatives is deemed to occur if the super fund invests money with one entity and that entity then on-lends that money to a member or their relatives.

Example 1

For example, the Smith SMSF has one member – John Smith. John wants to buy an investment property for $500,000 by purchasing 50% using his SMSF and 50% outside his SMSF. He doesn’t have the cash to fund his $250,000 share of the purchase price, but his super fund does. John decides to obtain some negative gearing tax breaks in his own name and he couldn’t be bothered going to the bank, and he thinks he can get around the financial assistance to members problem by getting his super fund to loan money to his mate, James Boyce, on commercial terms. James then on-lends the money back to John.

You would be surprised how many people the ATO catches doing this.

Example 2

Another variation of this problem occurs when the super fund invests in a related party, for example, a unit trust or company, and that entity loans that money to the member. An added complication with this structure is that it often leads to a breach of the in-house asset restrictions.

Financial assistance can also arise when the SMSF doesn’t enforce its rights. For example, suppose the other party is short of cash and it’s decided the party will take all the rent from the property for a period of time.

Alternatively, suppose the other owner is a fund member and their business, which has some cash flow difficulties, leases the property and doesn’t pay the lease costs, but nothing is done to chase-up the unpaid rent.

Note: there is nothing wrong with these types of joint ventures – purchasing property with another party is a perfectly legitimate strategy – you just need to proceed with caution and take steps to avoid some of the common mistakes mentioned.

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

Also in the Switzer Super Report

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