Valuation of SMSF Properties at Market Value – The SIS Regulations require trustees of SMSFs to value the assets of the fund at their “market value” when preparing accounts and statements.
To be in line with the ATO valuation guidelines, we advise that the Trustees obtain a real estate “kerbside” valuation (not a sworn independent valuation) for the properties annually. This will ensure that the assets held in the SMSF and in related entities, such as trusts, are reflected at market value, and rent is charged at commercial rates.
A real estate agent kerbside valuation is treated as an objective and supportable data to confirm market valuation of real estate properties.
We require the trustees to obtain a written real estate “kerbside” valuation to be used for the preparation of the 2016/17 financial statements of your SMSF. An email from a real estate agent will suffice if you cannot obtain a written letter.
Ultimately, the responsibility to value the investments of a SMSF at the correct market value rests with the trustees.
- Valuation of SMSF Properties at Market Value
- SMSF Owned Property and Public Liability Insurance
- Lease Arrangements between Your SMSF & Related Parties
SMSF Owned Property and Public Liability Insurance
Owners of all types of property have a duty of care to all individuals on their premises.
The Trustees of a SMSF could be sued if someone is injured or dies because of faults in that property.
In a 2010 judgment handed down in the District Court of New South Wales (Giovenco v Dick (2010) NSWDC 4), the judge found the owner of the property was liable for the death of a handyman who was hired to decommission an old solar hot/ water system and replace it with a new one. The handyman was electrocuted after coming into contact with an exposed wire from the previously used solar hot water heater.
The judge in the case found the property owner had breached their duty of care, as it was reasonably
foreseeable that someone could have been electrocuted.
Trustees at Risk
The super laws provide people with the ability to bring a claim against the Trustees of SMSFs to recover loss and damage, which may include action for negligence.
Now, if the property was owned by a SMSF with individual trustees, and the damages payable exceeded the value of the SMSF investments (including the property) – then the individual trustees themselves would be personally liable for any shortfall.
On the other hand, corporate trustees will have a limited liability as the company is a separate legal entity. If you own business or residential real property in your SMSF or via a unit trust, you should make sure you are aware, to the best of your ability, of any hazards on your business or residential real property.
If any hazards do exist, you should have them fixed.
Trustees should also consider having an insurance policy in the SMSF to cover the business or residential real property and public liability.
Please note that the insurance policy held through body corporate will cover the Common Property – this would normally include all the building structures. This will normally not cover the furniture, furnishings and possessions, carpets, drapes, ceiling fans, air conditioners, and hot water systems etc.
Therefore, you need to take out a ‘Contents Cover’ policy to cover those items, and ensure that it has a Public Liability component to give protection for an accident within your unit.
Please note that for a residential property, any public liability insurance cover is the responsibility of the landlord.
Even where the real property consists of vacant land, the need for public liability insurance should be considered.
We strongly recommend that all insurance policies that relates to the SMSF should be in the name of the SMSF or that the SMSF should be registered as an interested party on the insurance policy if the tenant takes out the insurance.
Lease Arrangements between Your SMSF & Related Parties
Part 8 of the Superannuation Industry (Supervision) Act 1993 (SISA) provides for business real property held by a SMSF and leased to a related party to be exempt from the ‘in-house’ asset rules. To meet the definition of ‘business real property’ the property must be wholly and exclusively used in one or more businesses.
To be exempt from the ‘in-house’ asset rules the property must be subject to a legally binding lease arrangement.
We would therefore strongly recommend that formal arm’s length lease agreements are in place at all times. We also suggest that trustees consider registration of long term leases against the property title.
Audits in the last couple of years, revealed that many SMSFs do not deal with their related parties on strictly commercial terms when it comes to business real property leases.
What are arm’s length terms?
The lease arrangement must be on an ‘arm’s length terms’ in order for the fund to comply with section 109 of SIS Act.
We would expect the lease to cover the following matters:
The amount of rent -the amount of rent should be at commercial rate. We recommend that trustees obtain Independent assessment of the market rate of rent and then base the rental amount on that Independent assessment.
Timing of rent payments – generally, we would expect the rent to be paid monthly in advance as would be the commercial practice for most types of commercial properties.
Rent review – the lease should have a clause defining when and by how much the rent is to be increased, for example, annual CPI increase. Rent should be maintained al a commercial rate for the term of the lease.
Term of the lease – the lease should provide a commencement date and an expiry date and identify any option periods, if applicable. The lease may provide for periodic tenancy either from commencement or from expiry of an initial term
Outgoings – the lease should define outgoings and specify which party is responsible for the payment of outgoings. Trustees should ensure that the amount of rent required by the lease is at a sufficient market rate if the decision is made for the fund to pay any of the outgoings.
Commercial practice dictates that certain expenses such as electricity, telephone and internal cleaning are usually tenant’s expenses.
The consequences of Trustees getting it wrong
There are numerous instances on record of SMSFs that failed to maintain the arrangement on arm’s length terms and thereby breached section 109 of SISA
The conflict of interest for a SMSF trustee in these circumstances is obvious and it is common for trustees to miss rental reviews and allow their related businesses too much flexibility when it comes to paying rent on time.
The trustees’ failure to chase payment/s from the tenant represents a form of financial assistance to that related party. Financial assistance represents another breach under S65 of the SIS Act.
While from a personal perspective, the trustees may wish to help their tenant through a difficult time, as trustees of the SMSF, they must ensure they act in the usual commercial way and pursue outstanding rent from their tenant otherwise they will breach the superannuation laws.
Where the SMSF received rent that is above the commercial rate, the risk is that, the portion of the rent that is more than the commercial rate could be taxed at 45% as non-arm’s length income.
It can appear that it is quite easy to ‘abuse’ the system when it comes to related party transactions, however section 109 of the SIS Act is enshrined within the SMSF independent auditor process to ensure that Trustees operate on commercial terms.
In certain instances, we as auditors are required to immediately report the matter to the ATO due to the value of the breach or non-compliant event involved. In other instances, an immaterial breach, such as the fund paying rates which the tenant should be paying, will also cause a contravention to be reported to the ATO if the breach occurs in more than one year.
ATO audits of these matters can be a costly exercise for a SMSF, not just in professional fees associated with the audit, but with the ultimate financial sanctions that the ATO can impose on a SMSF that fails to comply with the governing SIS legislation.
We recommend that Trustees:
- Pay attention to the above-mentioned issues and take necessary steps to ensure that SIS Act contraventions do not occur
- Ensure that the issues or breaches that were reported by the SMSF auditor are taken note of and addressed as soon as possible