When it comes to real estate, tax deductions and concessions for an SMSF depend on the property type and how it is used. Let’s look at the different ways in which real estate can be used and what’s available to SMSFs.
If your SMSF owns residential property, such as a freestanding home, terrace or apartment, the lease will usually be for set periods under a written lease for six months, a year or longer. The tenant will usually pay a bond as part of the lease and it will be held by the relevant government organisation until the lease has been terminated. Expenses relating to the property are eligible to be claimed from the day the property becomes available for lease. In many cases, your SMSF may employ a property agent to collect the rent and look after the day-to-day administration.
Any rent your SMSF receives less the relevant allowable deductions is included in the fund’s taxable income. Deductions can be claimed for rates and taxes, property administration costs and maintenance – some of these are outlined below:
Rates and taxes
- Body corporate fees and charges;
- Council rates;
- Water and electricity paid by landlord, but not those paid by the tenant; and
- Land tax.
- Insurance (building, contents, public liability);
- Advertising for tenants;
- Property agent's fees and commission;
- Some legal expenses; and
- Interest expenses – if the property is part of a limited recourse borrowing arrangement.
- Cleaning the property;
- Gardening and lawn mowing;
- Pest control;
- Repairs and maintenance but not the cost of improvements;
- Capital works deductions; and
- Travel expenses to inspect property (not deductible after 1 July 2017).
Don’t forget, just like all taxpayers, SMSFs cannot claim a deduction for the total cost of improvements to a rental property when they are incurred. Capital improvements such as the cost of adding a new room, remodelling a kitchen or bathroom or adding a pergola will be used to calculate the cost base of the property for capital gains tax (CGT) purposes. However, your SMSF can claim a capital works deduction based on the estimated cost of wear and tear to the property and any qualifying improvements.
Since 1 July 2017 there are restrictions on claiming tax deductions for depreciating second-hand goods, but it is still possible to claim deductions on depreciating new assets.
If your SMSF owns a holiday house it’s like owning a residential property but it’s more likely to be in an area which attracts holiday makers.
The holiday house will have many expenses common to a residential property. However, because the property is usually leased short-term more servicing and upkeep may be required. Also, your SMSF’s holiday house may include kitchen utensils, bed linen and furniture. A deduction is usually available for replacement of utensils, bed linen, depreciating furniture and more regular cleaning of the property.
There’s always the temptation that a fund member, trustee or one of their relatives may wish to use the property in the off season. This can be a problem for the fund as the value of the property will be included in the fund’s in-house assets. Your SMSF’s in-house assets are limited to no more than five per cent of the value of its total assets at market value. A breach of the in-house assets test can result in penalties being imposed by the Australian Taxation Office (ATO) and could require the sale of the holiday house.
Bed and breakfast
A bed and breakfast, as the name suggests, is usually short-term residential accommodation which includes breakfast. The standard of accommodation differs from place to place, however, the property is usually serviced and re-stocked regularly.
In addition to expenses incurred for a residential property, your fund’s bed and breakfast may also incur some of these expenses:
- Tea, coffee, milk, biscuits, bread and other consumable items;
- Paper towels, soap, detergent, bath gel etc;
- Magazines, books, newspapers etc;
- Energy costs such as gas and electricity;
- Internet, wi-fi and similar expenses;
- Depreciation on kitchen appliances, heaters, air-conditioners etc; and
- Laundry and cleaning expenses.
It is worthwhile to make sure that receipts for any of these expenses are kept substantiating the deduction. Any expenses relating to the bed and breakfast should be paid for by the fund where possible. This could be done by the fund having its own credit or debit card to make things as simple as possible. However, this may not be practical, and if the trustees pay the expenses personally, reimbursement should be made as quickly as possible.
Commercial property comes in all shapes and sizes from small shops to large factories. You may end up leasing the property from the fund on an arm’s length basis. Many expenses relating to the commercial property may be the tenant’s responsibility and you may be required to make good the property after it is vacated.
In some situations, any plant and equipment that is installed in the commercial building may be unique to the tenant’s business and may require a special fit out. The cost of the fit out would usually be incurred by the tenant as part of any lease agreement. However, if you or a related party are the tenant and pay for the cost of the fit out, care needs to be taken so that the cost incurred is not treated as a ‘contribution’ on the termination of the lease. The ATO’s taxation ruling TR 2010/1 provides information on whether certain expenses incurred on behalf of the fund could be treated as a contribution because the fit out has resulted in an improvement to the commercial property owned by the SMSF.
Your SMSF may own vacant land for various purposes such as a parking space for a business, farming land leased to a family business or for property development.
If the vacant land is used for genuine business purposes, the SMSF would be entitled to a tax deduction for expenses incurred in earning income or prospective income received from the land. This could include rates and taxes, repairs to gates and fencing or other structures on the land such as roads.
If the land is not genuinely held for income earning purposes there are no tax deductions for any expenses relating to the vacant land. This could occur if the land is held with the intention that it be sold or developed at a later stage - for example, if it is held for ‘land banking’. Generally, expenses for these purposes are added to the cost base of the property for CGT purposes.
Proposed legislation – vacant land
Whether evidence exists to establish that the fund holds the vacant land for future income earning purposes is a matter of contention between taxpayers and the ATO as there may be limited information available to establish its true purpose.
Draft legislation was released last year to formally deny deductions from 1 July 2019 for expenses associated with holding vacant land. If passed, the legislation will apply to all vacant land owned by SMSFs and individuals regardless of whether land was held before that time. This is targeted to prevent deductions being claimed for expenses for vacant land which was not held currently or prospectively for earning income.
The legislation has some exceptions that continue to allow deductions for expenses relating to vacant land which is used to carry on a business by a related party or that the land is used in a business of leasing if an unrelated third party is involved.
Here are some examples of how the legislation could work if passed:
The Nguyen Family Super Fund, an SMSF, owns a block of land on which the trustees intend to build a rental property. The block of land is fenced and has a large retaining wall, but it currently doesn’t include any permanent structure. As there is no permanent structure on the land the fund cannot deduct any holding costs for the land.
The Crown Family Super Fund, an SMSF, owns vacant land which is rented to the son of a fund member who uses it in his farming business. As the son is carrying on a business to earn assessable income and is a related party for purposes of the proposed legislation (spouses, children under 18 years old, affiliates and connected entities) the fund can deduct costs of owning the land.
The interesting thing about the proposed legislation denying expenses for non-income producing vacant land is to clarify the income tax law as it currently stands. However, if it is passed the amended law will apply to SMSFs and individual taxpayers.
There is nothing wrong with an SMSF owning a property either directly or indirectly or even one that is financed under a limited recourse borrowing arrangement. However, whether a tax deduction is available for expenses depends on the purpose and use of the property.
While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided.