Clients whose SMSF has pension accounts that exceed the $1.6 million limit can benefit from claiming capital gains tax relief on the value of assets they transfer back to accumulation accounts. However, there is one investment on which CGT relief could be lost unless appropriate action is taken.
By now, most professionals understand that the CGT relief for SMSFs differs depending on whether the segregated or proportionate method is used. Under the segregated method, the value of assets chosen for CGT relief cannot exceed the excess over the $1.6 million limit, with one of the few exceptions being a lumpy asset such as a property.
Under the proportionate method, trustees can choose to re-value some or all of the SMSF’s assets. Unless an SMSF has only a small percentage of members in accumulation phase, and nearly all of the assets of the fund have large unrealised gains, it will not make much sense to reset the cost base of all assets under the proportionate method.
Where the segregated method is used, no income tax is payable on the unrealised gain for the asset selected, while under the proportionate method, that percentage of the gain relating to pension fund members will not be taxed.
There is, however, one type of asset that many SMSFs hold for which resetting the cost base to market value as at June 30, 2017, will not result in a tax saving when the investment is sold. This is the case with unit trusts.
There are many SMSFs that have invested in unit trusts. In some cases, the unit trust holds assets purchased more than 20 years ago when it was used to buy a property with borrowed funds. In other cases, unit trusts have been used to facilitate two SMSFs investing in the same asset, such as a property or a business.
The trap for an SMSF claiming CGT relief on an investment in a unit trust stems from how capital gains unit trusts make are taxed. When a unit trust sells an asset for a profit, the capital gain is distributed to the unit holders in the year the gain is made. This means that to benefit from resetting the cost base of the units, the unit trust must be wound up in the year that the investment is sold, so that the proceeds the SMSF receives from the windup result in a capital loss.
Here’s an example. Suppose an SMSF owns all the units in a trust with a property that cost $600,000, and was valued at $1 million at June 30, 2017. Also suppose the trustees choose to reset the cost base of the units to $1 million as part of the CGT relief provisions.
If the trustees were to sell the property in 2018 for $1 million, the unit trust would make a capital gain of $400,000, which would be distributed to the SMSF as assessable income for the 2018 year. If the SMSF took no other action, it would be left paying tax on a portion of the $400,000 distributed.
If, instead, the unit trust were wound up prior to June 30, 2018, the SMSF would receive $600,000 in capital proceeds. Due to the cost base having been reset to $1 million, a $400,000 capital loss would be made on the windup. This would offset the $400,000 gain distributed by the unit trust, resulting in no net tax payable.