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SMSF Property 'improvements' by leasee

Discussion in 'Superannuation, SMSF & Personal Insurance' started by crab, 20th Apr, 2012.

  1. crab

    crab New Member

    Joined:
    20th Apr, 2012
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    Location:
    Newcastle, NSW
    Hi,

    We are setting up a SMSF that will be purchasing an industrial property -large block, shed & offices.

    This will be leased to a company (related) at market rent.

    my understanding is that the SMSF cannot make capital improvements to the property until it is mortgage free.

    But can the company leasing the property do such things.
    eg:
    Put a wall up in the shed, so that half can be subleased.
    put demountable sheds on the undeveloped land for rental as storage sheds, security gate, lights etc...


    Cheers for any insight
     
  2. Terryw

    Terryw Well-Known Member

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    I would say that is probably allowable as the improvements belong to the leasee and not the SMSF.

    But if the lessee were to move out an leave the improvment it could possibly be a deemed contribution to the fund if the leasee is a related party.
     
  3. jorgon

    jorgon Active Member

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    Location:
    Brisbane
    This is not quite the rule. The rule in section 67A(1) of the Superannuation Industry (Supervision) Act 1993 is that if the SMSF borrows money to purchase an asset, those monies are not used to "improve" the asset. The idea behind the restriction is to reduce the risk to the fund of speculation and gearing.

    Draft ruling SMSFR 2011/D1 states that you improve an asset "if the functional efficiency of the asset or the value of the asset is substantially increased through the addition of new and substantial features or rights or bringing a thing or structure into a more valuable or desirable form, state or condition than a mere repair would do".

    There is no restriction on improvements being funded by the SMSF from non-borrowed money. However the ATO say that this cannot be done to the extent that the acquired asset becomes a "different asset". If this happens, the limited recourse borrowing rules will be breached because more than one asset has become involved (the asset acquired must be a "single" asset). See SMSFR 2011/D1 for some examples, including the conversion of a hayshed to a house = a different asset.

    If your planned changes resulted in different titles being registered, then this would also breach the single asset rule. I do suspect that your fund's plan to divide the property to create separately lettable units could breach this rule, even if this does not create separately registered titles. However, this problem would seem to be avoided if the whole block is leased to a tenant and the tenant is permitted to subdivide and sub-let.

    However as Terryw says, the problem with the tenant carrying out such work is that if it enhances the value of the premises, this might amount to a deemed contribution to the fund by the tenant. Any such contribution could be reduced to zero however, by a carefully drafted lease with appropriate adjustments to the rent.

    The solution would seem to be a mixture of careful consideration of the type of "improvements" to be carried out and their permanency, who is to carry them out, and whether they will be carried out voluntarily or pursuant to a legal obligation.

    You can see that it is highly advisable to obtain professional advice on these matters.
     
  4. crab

    crab New Member

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    20th Apr, 2012
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    Location:
    Newcastle, NSW
    Thanks

    Thanks Jorgon & Terry for the insights..

    It may be that we use the SMSF for other investments, and purchase with a company to give us full freedom on this property..

    fingers crossed for the offer being accepted.
     
  5. Terryw

    Terryw Well-Known Member

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    Sydney
    Best to avoid using a company to purchase appreciating assets for tax reasons. Look at discretionary trusts.
     
  6. Superman

    Superman Well-Known Member

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    6th Nov, 2007
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    Location:
    Gold Coast, QLD
    Yeah - DO NOT buy property in a company structure.

    Generally, leasehold improvements should be paid for by the trading entity leasing and using the premises, enabling that income earning entity to receive the depreciation benefits.

    The draft ruling jorgon talks about has been finalised with virtually no changes so you can safely place reliance on it.

    If the improvements are made by the tenant, and the tenant leaves, depending on the terms of the lease agreement, the value of the improvements may become a windfall capital gain of the SMSF, OR a contribution depending on the situation and the intent of all the parties involved.

    I am sure the ATO would argue it is a contribution in this situation if the property was leased to a related party.

    SM :)