Investing in commercial premises through an SMSF – considerations for SME owners

One of the most important decisions small business owners make relates to their commercial premises.  Whether to rent or buy. Where to locate. How to get the style and comfort right as a long term proposition for team. And for those owners with an SMSF there is the additional consideration of purchasing the premises through their SMSF.

So lets take a look at the commercial, retirement and business considerations for small business owners of investing in commercial premises through an SMSF.

The SMSF lending environment.

In September 2007 more relaxed borrowing regulations were introduced in Australia. This gave SMSFs the capacity to use borrowed money to purchase an asset, such as real property. Albeit the borrowing arrangements permitted are subject to strict requirements.  Whereby you borrow money to purchase an asset within an SMSF using a limited recourse borrowing arrangement (LRBA). Under this arrangement the asset is held in trust, and any recourse the lender has under the borrowing arrangement is limited to the single asset purchased.

It is through the use of a limited recourse borrowing arrangement that small business owners have the ability to acquire an asset through their SMSF. This includes a commercial investment property. In this case the SMSF is the owner of the premises and the business is the tenant paying a market rent to the SMSF. The owner is able to purchase a new property or transfer an already owned commercial property into the SMSF. 

What are the commercial, retirement and business benefits?

• It gives the business owner the ability to purchase their business premises and own an asset for retirement. Effectively using gearing as a strategy to grow their retirement income.
• It takes advantage of the higher level of protection of assets within super.
• The rent that the business pays into the SMSF will not be treated as a superannuation contribution. This gives the owner the ability to still contribute their concessional contribution and collect an additional commercial rent at the same concessional tax rate of 15%.
• The tax benefits compared with other investment earnings. Where an investment property is held in your own name, tax will generally be payable based on your personal rate of tax – which could be up to 46.5% or 30% if owned through a company. This compares to the concessional rate of 15% that applies to superannuation investment earnings – in this case the rental income.
• As a business owner, it frees up capital by unlocking their super, avoids a large capital expense for the business in purchasing commercial property, and facilitates rental and location stability for the business.
• The rent that the business pays into the SMSF will be tax deductible to the business.
• The owner can also protect themselves from Capital Gains Tax. Paying up to 10% CGT if they sell in accumulation phase or as little as no tax in pension phase.
• When the business is sold or the owner retires, for a small business owner superannuation assets are not included when determining eligibility for small business CGT concessions.

On the flip side of the shiny self-management coin, what are the important considerations?

• There is an absolute element of responsibility on compliance matters. The business owner is the trustee of an SMSF and needs to understand what those responsibilities entail.
• The business owner must pay commercial rates for rent through a prearranged lease agreement.
• While having a protected asset will work for some businesses, the owner must accept the equity is locked within the fund.
• Borrowing or gearing super into property must be done under a ‘limited recourse borrowing arrangement’. This can only be used to purchase a single asset.
• SMSF establishment costs including advice fees and structural set up costs need to be budgeted in.
• SMSF property sales may have additional fees and charges that add up and reduce the super balance. These include upfront fees, legal fees, stamp duty, property management fees and bank fees.
• SMSF property loans tend to be more costly than other property loans and repayments must be made from the SMSF. This means the fund must always have sufficient liquidity or cash flow to meet these repayments.
• Any tax losses from the property cannot be offset against the owners taxable income outside the fund.
• Until the SMSF property loan is paid off alterations to a property cannot be made if they change the character of the property.

In summary.

Buying commercial space through an SMSF can be an effective strategy for some business owners. However make sure you seek professional advice and take the time to ensure you understand not only the benefits for your business, but also the costs and risks involved with such a strategy.

Anthony Landahl | Equilibria Finance

Note: This is for general information purposes only and does not constitute advice. With all of these options there are a number of considerations outside the scope of what is covered in this article that you need to understand to ensure your personal circumstances are taken into consideration.