Is your SMSF breaking the law?

SELF-Managed Super Funds (SMSFs) appeal to us for the control they give us over our money. However, if you’ve lost money in the past 12 months, you may inadvertently be violating the in-house asset rule. To make sure you stay on the right side of the law, here’s everything you need to know about the in-house asset rule, with all your nitty-gritty questions answered.

What is the 5% in-house asset rule?

The in-house asset rule dictates that SMSF owners should not directly benefit from the money set aside for their superannuation until they reach retirement age.

For this reason, no more than 5% of the total value of the fund may be invested in a manner which serves fund members or related parties before they reach retirement age.

Why does the rule exist?

It may seem a little unfair – after all, why shouldn’t you be able to benefit from your own savings? But the rule exists for a good reason – to protect you.

The in-house asset rule has its roots in government legislation put in place in the early days of super to protect workers from self-serving employers who were investing their employees’ super into their own company.

It is easy to imagine why these arrangements worried the government because members’ risk was twofold: if these companies were to fail, members stood to lose both their income stream, and retirement savings.

Rules were put in place to govern superfund investment in businesses or assets that were somehow “related to” the manager of the fund.

Over time, these rules have been extended to include not only employers, but individuals who were looking to invest or loan to related parties – members, companies or trusts.

Today there is a 5% limit placed on legitimate in-house assets. Meaning that if you have $500,000 total in your fund invested you may have a maximum of $25,000 exposed to legitimate “in-house assets” – and even that $25,000 is no free-for-all.

So what is a legitimate in-house asset? Multiport technical services director Phil LaGreca takes us through some of the most common in-house asset scenarios and shows us those SMSF traps to steer clear of.

Can an SMSF loan money to a related party or business?

SMSFs may lease to related parties via a private company but may never loan directly to individual members.

These leases or loans do count towards in-house assets and must be less than 5% of the total value of the SMSF.

Similarly, an SMSF may take a loan for, say, $25,000 worth of shares in a private company between itself and other related parties or as part of a trust structure where the member and relates parties control up to 50% of unit holdings.

Can an SMSF purchase or lease a car to a related party?

Your SMSF cannot buy you a car as a gift, but it can lease one to you on a commercial basis provided the value of the car is less than 5% of your whole SMSF portfolio.

“The other aspect of that is that the lease absolutely must be commercial. You couldn’t lease a $25,000 car at a rental of $1 per week as this is not a legitimate commercial rate,” LaGreca said.

So, if a vehicle lease company would rent the car for $200 a week you must pay your SMSF the same.

Can an SMSF purchase property and rent it to a member?

Technically yes, it is possible for your SMSF to purchase residential property and lease it to you but you would be limited by the 5% rule.

To begin with, you would need to have either a multi-million dollar portfolio or a very cheap property for this to work.

In order to purchase and lease a $400,000 home, your SMSF would need more than $8 million.

However, the SMSF can buy a property that the investor intends to live in after retirement. This is possible if you transfer the property from your super fund to yourself after you retire.

There is an important exception to the 5% rule where property is business related.

There is no rule that prohibits an SMSF from owning commercial property and leasing it to the business of a related party.

For example, an SMSF could purchase a warehouse or factory and let the space to a related party. Once again, this is provided the rent is at a commercial rate.

This is an important exception and many professionals use their super fund in this way. For example, a dentist or doctor’s surgery may be owned by their super fund.

However, this does not apply to those who work from home. The rule for business property is that premises must be wholly and exclusively used for business purposes.

For example, the shop front with the apartment upstairs does not slip through the exceptions.

Though there are a couple of unusual exceptions:

• Rural Property: In the case of rural property, SMSFs may invest in the whole estate including a residence used by the property manager who may be a fund member or related party. 
• Hotels and Motels: Where concierge or management that live onsite are required to be there 24 hours a day it follows that the whole function of the residence is for business.

Can the SMSF buy artwork, collectibles and other exotic assets?

Technically yes, your SMSF can buy artwork and collectibles, but the question becomes: Where are you keeping them?

If your artwork, collectable, antique car or furniture is purchased by your SMSF but kept in your family home it must be valued at less than 5% and you must be leasing it at a commercial rate for it to be classified as a legitimate investment.

“If your SMSF buys art or furniture for your house, and you are not paying a lease rate for it, it means you are getting an immediate entitlement to the benefits of your super before you are actually entitled to it,” LaGreca explained.

“Just as individuals in regular super funds must reach preservation age before reaping the benefits of their investments, SMSF members must keep it commercial until they are entitled to access their assets.

“If in-house assets are contributing to their lifestyle or enjoyment (for free) prior to retirement – this is in breach of the sole-purpose test.”

However, if you are paying extra money into your super and “renting” art works from your own super fund, this is considered acceptable.

Many mainstream super funds have exposure to art collections that are rented out to large offices in this way.

There is nothing to prevent SMSF investors from purchasing art, coins, stamps or rare books, however as you move further away from investing in financial assets, matters also become more complex.

You will need to closely consider issues such as valuations, location, storage and insurance – shares can’t be burnt, stolen or damaged but exotic assets can.

SMSF members should constantly be cross-checking that their purchases fit with their investment strategy.

What’s the point of having a massive art collection if you are trying to pay a pension?

Although technically you can do it, you should consider the ramifications of purchasing assets that are not easily tradable – and that applies to property as well.

Is your SMSF breaking the law?

The sum of all in-house assets owned by your SMSF should work out to less than 5% of your total assets.

Every asset should comply with the sole-purpose test and have been purchased expressly for the purpose of providing for you in (and in no way prior to) retirement.

If you are still unsure about whether your SMSF may be exceeding the in-house assets rule, or whether your investments may breach the sole-purpose test, get in touch with a financial advisor who can help.

Where to find out more

Contact Phil LaGreca at Multiport.com.au