The SMSF Related-Party Property Purchase
An SMSF with two members, both in accumulation, has $1.2 million in assets: $700,000 in listed shares and $500,000 cash. The trustees want to buy a $650,000 commercial warehouse from the sister of one member at market value, funded by cash plus a limited recourse borrowing arrangement. The fund's trust deed permits borrowing. The member's sister will lease the property back to the member's business at $55,000 per year. The auditor has flagged that the fund has no written investment strategy update and that one trustee signed the loan documents without the other.
1. Is the purchase permitted? Identify the compliance issues and how they should be resolved.
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A related-party acquisition is permitted only if the asset is acquired at market value and the acquisition is not prohibited. Business real property is the key exception: an SMSF may acquire business real property from a related party at market value. The warehouse, if used wholly and exclusively in a business, may qualify, but the trustees must obtain a written independent valuation supporting $650,000 and document the arm's-length terms.
Issues: (1) the LRBA must be a single asset, with the asset held on trust and the fund holding a beneficial interest; the lender must be a third party or a permitted related party, and the borrowing must be on commercial terms; (2) the fund must have an investment strategy addressing diversification, liquidity, and the borrowing; (3) both trustees must sign - a single trustee's signature may invalidate the document and breach the trustee covenants. The trustees should obtain legal advice, a valuation, a written investment strategy, and a properly executed loan and lease before settlement.
2. Assess the $55,000 lease and the fund's liquidity and diversification position.
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The lease must be on arm's-length terms; $55,000 on $650,000 is an 8.5% yield, which may be above market and could be seen as a related-party benefit. An independent rental appraisal should support the figure. More importantly, the fund would hold $650,000 in one illiquid property out of a $1.2 million fund - over 50% in a single asset - plus a loan. Liquidity is a serious concern: the fund must be able to pay benefits and loan repayments. With $700,000 shares and the property, the fund is concentrated and geared.
The investment strategy should set target ranges, address the risk of a single asset and the gearing, and plan for liquidity. The trustees should consider a smaller property or a larger cash buffer, and document why the concentration is appropriate for the members' ages and risk tolerance.
3. What are the consequences if the auditor's findings are not addressed?
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Unaddressed contraventions can lead to the fund being made non-complying, with the fund's assets taxed at 45% (less the 15% already paid), and the ATO may issue a direction, an administrative penalty (up to 60 penalty units per trustee per contravention for some breaches), or disqualify trustees. The auditor must report contraventions to the ATO. The trustees should self-report and rectify where possible, obtain an updated investment strategy, ensure all trustee signatures are obtained, and document the arm's-length valuation and lease. Rectification before ATO action generally reduces penalties.