When can residential property meet the definition of business real property?

One of the questions we are asked regularly as Self-Managed Superannuation Fund (SMSF) advisers is whether the fund can purchase a residential property owned by the member or a related party.

Property can be acquired from a member or related party of an SMSF if the property meets the definition of Business Real Property as defined in Section 66 of the Superannuation Industry (Supervision) Act 1993. Section 66 defines business real property as a real or leasehold interest in property used wholly and exclusively in one or more businesses.

The definition does not refer to whether the property is commercial or residential. The question to be asked is whether the property is wholly and exclusively used in a business.

Residential property will satisfy the definition of business real property and accordingly can be purchased from a related party by a fund where either:

  • The number of residential properties owned by the related is such that it is considered the related party is in the business of managing a pool of residential properties
  • The residential property is used in the related party’s business, for example, an office or surgery in the case of a dentist, vet or doctor
  • The residential property is the trading stock of a business, for example, a developer.

We have outlined some of the factors you should consider when determining whether a residential property is business real property. 

The business of managing a rental property portfolio

Seven years ago, an Administrative Appeals Tribunal (AAT) concluded that an individual was “in the business” of operating a business managing rental properties, even though they had never made a profit.

The facts of that case (YPFD v Commission of Taxation (2014) include:

  • The taxpayer owned nine rental properties, which were managed on a part-time basis.
  • The taxpayer was employed on a full-time basis as a scientist – so they were not entirely focused on the rental property business
  • They put a significant amount of time into managing the portfolio and managing the real estate agents that carried out some tasks related to the property portfolio
  • They did not have a business plan
  • They had never made a profit – but the Tribunal decided they intended to do so.

The issues that the AAT took into account in determining that the taxpayer was running a business of managing rental properties were:

  • The intention to build the rental property pool and make a profit
  • The repetition and regularity of the activities the taxpayer undertook in managing the properties
  • The complexity of the holdings, the magnitude of the business and the amount of capital invested.

When all of the above factors were considered by the AAT, it was decided that a person could be operating a business of managing rental properties.

This position has been reinforced by the Australian Taxation Office (ATO) ruling on Business Real Property SMSFR 2009/1, which confirms in several examples that residential property can meet the definition of real business property and, therefore, be acquired from a related party SMSF.

Residential property held in a property investment business- Example 14 of SMSFR 2009/1

  • Mr Wood owns 20 residential units that are leased to long-term residents. Mr Wood manages and maintains the flats on a full-time basis living on the income generated from the leases
  • The units are not mortgaged
  • Mr Wood would like his SMSF to acquire some of the units rather than sell the units to a non-related party
  • The scale of the operation, together with the elements of repetition and purpose, indicate Mr Wood is carrying on a property investment business
  • Even though the tenants use the properties for their own private or domestic purposes, this use remains incidental and relevant to Mr Wood's property investment business. Consequently, Mr Wood's interest in the property on which the units are built is business real property. Provided the acquisition takes place at market value, the units may be acquired by the SMSF without contravening the related party asset acquisition rule in section 66.

Residential property used in another business 

Provided property is used wholly and exclusively in a business, it does not matter if it is residential or commercial. Examples of properties used in this way could include:

  • A residential property used as an office for a professional or doctor surgery
  • A residential property used to operate a bed and breakfast business.

Once again, SMSFR 2009/1 contains an example that demonstrates the ATO’s interpretation of that matter.

Doctor's surgery in residential premises

  • Dr Mary owns a house used exclusively by her medical practice
  • Dr Mary is a member of the Yianni SMSF, and in her capacity as trustee of the SMSF, wants to acquire the house for market value and then lease it back so the medical practice can continue to operate from the house
  • Although the house was built to be residential premises, it is not used as such
  • The real property is used wholly and exclusively in Dr Mary's medical practice business
  • For the purposes of the related party asset acquisition rule in section 66, the property is business real property of Dr Mary
  • Once acquired by the Yianni SMSF, it is also business real property of the fund and is therefore not an in-house asset of the SMSF.

What you need to know

The legislation allowing an SMSF to purchase business real property was initially legislated to enable small businesses to hold their business premises in their superannuation fund. Given this concessional manner in which assets are taxed when held by a superannuation fund, this can be a beneficial strategy for business owners to use when planning their retirement.

However, it is not always clear when a property will satisfy the definition of business real property, so if this is an area that interests you, please contact your BDO adviser.