Investing in overseas property for an SMSF

An important part of a fund’s investment strategy is for trustees to consider diversification of assets. This can take place amongst different investment classes, but also within a particular investment class. Take for example real estate, which can be invested in different types of residential and commercial property in Australia, and overseas.

The latest ATO statistics for the December quarter 2020 tell us that there is approximately 24% of the total assets of all SMSFs invested directly in commercial and residential real estate¹. Many SMSFs hold Australian real estate, but some own overseas commercial and residential real estate, which has a total value of $331 million and $137 million, respectively. So, if the property market in Australia is a little too hot at the moment maybe, there may be possible to diversify into a cooler real estate climate overseas. But before going ahead, there are some issues that should be considered compared to purchasing property locally.

The superannuation law governing fund investments applies to property owned by the fund - whether it’s in Australia or overseas. Here are some discussion points to consider when contemplating buying property outside of Australia.

Trust deed

The fund’s trust deed is a good starting point to see whether it permits the fund to purchase assets outside of Australia. Most deeds place no limits on trustees making investments in Australia, but it’s worthwhile confirming there are no restrictions or limitations on an SMSF acquiring property overseas.

Investment strategy

All super funds are required to formulate and implement an investment strategy, which may include property, and particularly overseas property. A review should be made of the investment strategy to see if an overseas property investment can be made. If the investment strategy does not include overseas property, then an amendment may be required. The strategy may also needs to consider the nature of the property investment, such as the risks associated with overseas property and the liquidity issues of holding property. A previous article on ‘SMSFs and property – a liquidity risk?’ discusses the risks involved when investing in real estate².

Dealing with a related party

If the fund acquires an overseas property from a ‘related party’, such as a member of the fund or a close relative, the investment may be limited to acquiring ‘business real property’ (BRP). Furthermore, BRP can be leased or used only by a ‘related party’ and the trustees need to make sure a market rent is paid. Just because the property is situated overseas, the trustees cannot use it even for a short time, even if they are on holiday. Staying in a property that does not meet the BRP definition, in other words ‘residential property’, will result in it being treated as an ‘in-house asset’ (IHA), even where market rent is paid. In most funds, it’s likely that the fund will contravene the IHA rules because the value of the property may be greater than the IHA limit, which is equal to 5% of the value of the fund.

Ensuring no charge over the property

The superannuation legislation prohibits the trustee from placing a charge over any fund assets. However, it is possible to put a limited recourse borrowing arrangement (LRBA) in place. An LRBA allows an SMSF to borrow funds to purchase an asset which is held in trust. This may prove difficult for an overseas property as a lender may be difficult to approve the financing, and the laws of a foreign country may not recognise the technical requirements for the fund to comply with the rules for LRBAs.

Who holds title of the property?

The superannuation law requires the trustee(s) of the SMSF to hold the legal title of the property, except for LRBAs or where a custodial arrangement for holding fund assets is in place. It is common that the foreign country may not to recognise the SMSF structure, and may require a local entity to be used. For example, in the US, a limited liability corporation (‘LLC’) can be used to acquire US property, with the SMSF being the ‘shareholder’ of the LLC. This presents some superannuation compliance issues with the LLC needing to comply with the ‘non-geared entity’ rules under the superannuation law.

The Australian laws which apply to LRBAs only allows for assets of the LLC (being the non-geared entity) which are property and deposits with banks that are regulated by the Australian Prudential Regulation Authority (APRA). A simple act of opening a US bank account, which is not regulated by APRA, in the LLC’s name to receive rent and pay expenses of the property may result in the structure not complying with our superannuation law.

Local taxes

In addition to compliance with Australian taxation requirements, the SMSF may have an obligation to adhere to the local tax law in the overseas country and pay any relevant local charges. This may require engagement of a local advisor to attend to any taxation and administrative issues, which may increase the costs associated with owning the property. Given the greater distance involved, there would need to be a higher level of confidence and trust in the overseas agent used to collect rents and pay any expenses.

Collection of rents and payment of outgoings

Where a fund purchases an Australian property, it is common to engage a real estate agent to collect rents, attend to payment of expenses and liaise with the tenant regarding general property issues and maintenance. In addition, the fund does not qualify for a tax deduction if the trustees travel to inspect the property. Furthermore, an understanding of the agency costs and frequency of remittance of rents collected and statements should be confirmed.

Currency conversion and fluctuation

Trustees need to consider the currency risk that comes with the fund owning assets overseas. On one hand, the value of the asset may be increasing, however, on the other if the exchange rate is not favourable, any gains may be reduced because of currency fluctuations.

For Australian taxation purposes, all transactions in relation to the overseas property must be converted into Australian dollars. This may carry with it increased bank and administration costs.

SMSF compliance costs

Accounting for an overseas asset, together with correct tax treatment can lead to increased administrations costs. This could include confirmation of taxes in the local tax jurisdiction or understanding the impact of any Double Tax Treaty that exists between the foreign country and Australia.

An overseas property can be eligible to a claim a tax deduction for depreciation and building allowances. However, this may depend on the date of the construction of the property. Also, it may be necessary to engage the services of a quantity surveyor to make an estimate of costs and prepare a report on the property.

Further, for any real estate situated overseas the fund’s auditor may not be able to satisfy themselves in relation to aspects of the property, including its existence and market value. This may result in the requirement for a qualified audit report and/or additional audit cost. Qualified audit reports may lead to further scrutiny by the regulator (Australian Taxation Office).

Sovereign risk

Owning a property in a foreign country means dealing with the laws of a foreign government. Just like in Australia, a foreign government can change the law at any time, which may mean the investment is no longer viable. In this situation, the trustees may need to develop an exit strategy for the fund.

In addition, consideration should be given to the possibility of ownership of the property reverting to the foreign power with no compensation to foreign investors.

In a nutshell, there’s a lot to think about for trustees intending to purchase a property overseas and whether it is considered a worthwhile and enduring investment.

¹ SMSF Statistical Report - December 2020; https://data.gov.au/data/dataset/2fd970ec-984e-4593-bbad-2e69a5fa7a89/resource/ad70308d-ff84-4313-81d1-e30d0b274f29/download/smsf-quarterly-statistical-report-december-2020.xlsx
² https://www.ampcapital.com/au/en/insights-hub/articles/2021/april/smsfs-and-property-a-liquidity-risk