My SMSF owns a property - could I live in it?

It’s almost always a hard “no” to this question.

There are some exceptions – for example, if the SMSF owned a hotel and it was managed by its members, it’s likely they could live on site. But for the vast majority of people, it’s not possible to live in a property owned by their SMSF for a couple of reasons.

Firstly, all super funds have to comply with what’s known as the “sole purpose test”. We covered this in a recent article here. But in brief, this test is all about funds being run for the sole purpose of saving for retirement or looking after a member’s immediate family if they die. It is a test the trustees have to think about whenever a super fund does anything, including buying investments: “are we buying this because it’s a good way of saving for retirement or do we have some other reason that’s actually the driver?”.

A decision to buy a property so that the members, their family or even friends or acquaintances could live there would fail this test.

Even if the property was an adequate investment, the important question would be: what drove the decision? Was it genuinely motivated by finding the best possible investment for retirement savings or something else?

The sole purpose test would also stop SMSF trustees from doing other things. For example, they couldn’t buy a property from a friend because they wanted to help the friend release some cash. Nor could they transfer a business premises they owned personally to their SMSF because they wanted to free up some cash themselves. In both cases, those transactions might be fine if they were undertaken for different reasons – ie, because the trustees felt these investments were the best option for their retirement savings. But they’re a problem if the motivation was to help the seller.

But what if the circumstances were different and the motivations for buying the investment are absolutely right – maximising retirement savings. Would anything get in the way of a member living in the property owned by their SMSF then?

Generally, yes.

Perhaps the lawmakers knew how hard it would be to be true to the sole purpose test or perhaps they just wanted to be extra sure that super monies are protected. For whatever reason, there are a number of extra rules in super law when it comes to dealing with “related parties”. (Related parties are generally the members themselves, their relatives and other entities like companies or trusts that the members and their family control.)

A few are highly relevant for this question.

For example, if an SMSF rents a residential property to a related party, the property becomes what is known as an “in-house asset”. Super funds are only allowed to invest up to 5% of their total asset value into in-house assets. Unless the fund is very large (so the property represents less than 5% of its assets), that essentially makes it impossible to do. Unfortunately the fund can’t get around this by not charging the related party rent – there’s no escaping the long tentacles of the in-house asset rules.

In our business, we’re often asked about this when it feels like the situation  "should"  be OK. A common scenario might look something like this: the property was genuinely purchased for the right reasons (no sole purpose test problems). Initially it’s rented out to a tenant that isn’t connected with the family at all but when their lease is up, a family member asks to move in. It looks like a perfect solution for everyone involved – the SMSF trustees have a reliable tenant, willing to pay market rates of rent and obviously motivated to look after the place well. The potential tenant has the security of knowing their landlord will be fair when it comes to honouring the lease and won’t evict them with minimal notice.

But unfortunately it's still a problem.

No matter how carefully the arrangement is structured to be completely above board (with proper lease agreements, market rents and all lease conditions adhered to etc), nothing can change the fact that the property has become an in-house asset and caused the fund to exceed its 5% limit. That happens simply because it is now leased to a related party. And the definition of “relative” when it comes to related parties is not just immediate family – it includes aunts, uncles, nieces, nephews, siblings, parents, children, in-laws and more.

Interestingly, super law applies different standards when the property involved is “business real property” (ie commercial property). Business real property can be leased to related parties without being classified as an in-house asset. So while the sole purpose test would still be vitally important, an office building (say) owned by an SMSF can be rented to a member’s business or a business run by another family member without needing to worry about the 5% ceiling.

For business real property, it’s critical that it all happens on commercial terms. The rent must be at market value, the lease properly documented and its terms should be followed to the letter. For example, if rent is supposed to be paid monthly and is increased in line with inflation every 12 months, that must happen in practice. But as long as these requirements are met, it’s possible (in fact common) for SMSFs to lease business property to related parties.

And that’s perhaps why people so often assume that it will be fine to do the same with residential property, but unfortunately the rules are completely different.

In fact the rules are even different when it comes to buying the property in the first place. This is a topic for another time but – spoiler alert – SMSFs can acquire business real property from related parties (subject to some conditions) but they can’t do this with residential property. Residential property can only be bought from people or entities that aren’t related parties, and then can only be leased to people or entities that aren’t related parties.