Related Party Property Purchase and In-House Asset Rules
An SMSF with two members, both in accumulation, holds $900,000 in cash and listed shares. The members want to buy a commercial warehouse from a business owned by one member's brother for $1.1 million. The fund would need a limited recourse borrowing arrangement of $400,000 from a bank. The warehouse would be leased to the brother's business at market rent. The fund's trust deed allows borrowing and investment in direct property. One member's employer-sponsor is the brother's business, which contributes $15,000 a year to the fund. The trustee asks whether the purchase is permitted and what needs to happen before settlement.
1. Analyse whether the fund can acquire the warehouse from the member's brother and how the in-house asset rules apply.
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The acquisition is from a related party of a member. The fund can acquire business real property from a related party at market value; the warehouse qualifies if it is used wholly and exclusively in a business, which the lease to the brother's business supports. The price must be supported by an independent valuation, and the deed must permit it. The in-house asset rules then apply: the warehouse is not an in-house asset if it is business real property, so it is excluded from the 5% limit. However, the loan from the brother's business or any lease arrangement with a related party must be on arm's length terms. The bank loan is not a related party loan. The trustee must also consider whether the employer-sponsor contribution creates any issue; it does not, but the fund should not lend to the business. The key risk is that if the property were later used other than wholly and exclusively in a business, it could become an in-house asset and breach the 5% limit.
2. What are the borrowing requirements and the consequences if the LRBA is not structured correctly?
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The LRBA must be a single acquirable asset, and the warehouse is one asset, so that is satisfied. The lender's recourse must be limited to the asset, and the asset must be held on trust under the arrangement until the loan is repaid. The trustee must ensure the borrowed money is used only to acquire the asset and meet costs, not to improve it; improvements must be funded separately. If the structure fails, the fund may breach the borrowing rules, and the ATO could treat the arrangement as not complying, potentially making the fund non-complying. The trustee should also check the deed allows borrowing and that the custodian trust is properly documented. Repayments must come from fund resources, and the fund must have a plan if the tenant vacates, since the loan repayments continue regardless of rental income.