When a financial professional has clients with self-managed super funds, one of their main jobs is to educate the trustees on what they can and can’t do. Thankfully most clients don’t breach any superannuation regulations, but when there are breaches they are relatively minor and do not result in financial or tax penalties.
There are however some clients that think if they are careful and clever enough breaches of the regulations will go undetected. Many of these breaches tend to be related to property investments. Unfortunately when one of these breaches occur the penalties and financial cost can far outweigh any temporary benefit that may have been achieved by using SMSF funds improperly.
Several years ago when processing the annual accounts of an SMSF I noted that the fund had purchased a property in a seaside resort area where the clients owned a property. Fearing a breach of buying assets from related parties I was relieved to discover the SMSF had purchased the property from an unrelated party.
The property was rented through a local agent to a tenant for 12 months with the rent appearing to be at a commercial rate. At this point the SMSF did not appear to have breached any of the superannuation regulations with the property investment.
‘Unforgiving’ super regulations
When further processing real estate agent’s and bank statements it became evident that one of the tenants paying the rent had the same surname as the trustees of the SMSF. After querying the clients they advised that the property in fact was rented to their daughter and her boyfriend who were attending a nearby university.
One of the most unforgiving superannuation regulations is the 5 per cent in-house asset limit. When an SMSF exceeds the 5 per cent limit as at June 30 of any year, the trustees must prepare a written plan to dispose of one or more in-house assets to reduce the value back to no more than the 5 per cent limit.
In my client’s case the SMSF’s total assets had a market value of approximately $2 million, and the value of the property purchased was $400,000. When I advised my clients that they had breached the in-house asset test, by having 40 per cent of the fund invested in a property rented to a related party, they thought that they could fix the problem by having their daughter move out and renting to an unrelated tenant.
They then got the bad news that as they had breached the 5per cent in-house asset rule they had only one option, and that was to sell the property. When I advised them that if the auditor discovered the breach, and we did not have a plan in place to sell the property, the breach would have to be reported to the ATO.
At risk of losing complying status
If they chose not to sell the property but find an unrelated tenant I advised the fund could be classed as non-complying and lose 49 per cent of the value of its assets in tax penalties, and they personally could also face ATO penalties of up to $10,800 each.
Finally, recognising the full implications of breaching the in-house asset limit, the clients agreed to prepare a plan to sell the rental property. When the accounts were sent to the auditor the plan (to sell) was too, and documents included showing an agent had been appointed to handle the sale.
Although the clients with the super fund did not have any penalties imposed by the ATO, by having breached the in-house asset test, they made a loss on the sale of the property after taking into account the selling costs.
