Avoid These 5 Mistakes When Buying an Office with Super

You Can Still Borrow Through Your SMSF for Commercial Property

SMSFs can still use borrowed money to buy commercial property, including an office building. The changes that came into effect on 10 August this year only restrict new borrowing arrangements for residential property. If you're looking at an office, warehouse, or other business real property, the Limited Recourse Borrowing Arrangement rules still apply exactly as they did before.

The property has to meet the definition of business real property under the Superannuation Industry (Supervision) Act. That means land and buildings used wholly and exclusively for business. The business doesn't need to be yours. If you're buying an office to lease back to your employer or to an unrelated tenant, that can qualify, provided the property is used entirely for business purposes and not as someone's home.

Consider a FIFO worker in the northern suburbs who built up $400,000 in super and wanted to buy a small office in an industrial precinct near Port Adelaide. The property was tenanted by a logistics company on a five-year lease. Because the property was used wholly for business, it qualified as business real property. The SMSF borrowed 70 percent of the purchase price under a Limited Recourse Borrowing Arrangement, with the property held in a bare trust until the loan was repaid. The rental income covered most of the loan repayments, and the remaining amount was topped up from the member's ongoing concessional contributions.

What Lenders Actually Look for in an SMSF Commercial Loan

Lenders assess the SMSF's ability to service the loan, not your personal income. Rental income from the property is the main serviceability factor. Most lenders want to see that the rent covers at least 120 to 140 percent of the loan repayment. If the property is vacant or the lease is due to expire soon, some lenders won't proceed until a tenant is secured.

Deposit requirements are higher than residential loans. Most lenders require at least 30 to 35 percent of the purchase price to come from the SMSF's cash or liquid assets. You can't use equity in your home or personal savings. The SMSF has to hold the deposit in its own name. If your fund balance is sitting mostly in shares or managed funds, you'll need to liquidate enough to cover the deposit and associated costs such as stamp duty and legal fees.

Variable rates for SMSF commercial loans sit higher than standard residential loans, and fixed rate options are less common. Loan terms are typically capped at 15 years, though some lenders offer up to 20 or 25 years depending on the member's age and the property type. Loan-to-value ratios are capped at 70 percent for most commercial properties, and some lenders go lower depending on location and tenant strength.

The Holding Trust Requirement Catches People Out

The property can't be owned directly by your SMSF while the loan is outstanding. It has to be held in a separate bare trust, sometimes called a holding trust. The SMSF holds the beneficial interest in the property, and legal ownership transfers to the SMSF once the loan is repaid.

You can't use a discretionary trust or a unit trust where the SMSF is one of multiple unit holders. The trust deed has to specify that the SMSF trustee has the right to acquire legal ownership of the asset after the loan is paid off. Most lenders and SMSF administrators arrange this structure as part of the loan setup, but if you're setting it up yourself or using a related party lender, the trust deed needs to be drafted correctly or the arrangement won't meet the legislative requirements.

The asset held in the trust can't be subject to any other charge or security. That means you can't use the same property as security for another loan, and you can't borrow more money later to renovate or extend the building. Any improvements have to be funded from the SMSF's cash reserves or from rental income, not from borrowed funds.

Leasing the Property Back to Your Business or Employer

If you're self-employed or run a company, you can lease the office building from your SMSF. The lease has to be on arm's length terms at market rent. If the ATO considers the rent to be below market value, the income might be treated as non-arm's length income and taxed at 45 percent instead of the concessional 15 percent rate.

Market rent needs to be supported by a formal valuation or a rental assessment from a licensed property manager or commercial agent. The lease agreement should be documented properly with terms that reflect what an unrelated tenant would accept. Informal arrangements or handshake agreements put the fund at risk of breaching the sole purpose test, which requires the SMSF to be maintained solely to provide retirement benefits, not to give you or a related party a present-day benefit.

Many FIFO workers in South Australia set up this structure because they want to build an asset in their super while their income is high and they're working long rosters. The rent paid by the business or employer is a deductible expense for that entity, and the rent received by the SMSF is taxed at 15 percent during accumulation phase or potentially exempt during pension phase, depending on how the fund's assets are segregated.

Refinancing After the August Rule Change

If you already have a residential property LRBA in place and want to refinance, you can. The changes that started on 10 August don't affect existing arrangements or the refinancing of those arrangements. You can switch lenders, negotiate a lower rate, or move from a variable rate to a fixed rate without triggering the new restrictions.

Commercial LRBA refinancing is also unaffected. The refinanced loan has to relate to the same single asset, maintain the limited recourse character of the original arrangement, and meet arm's length terms. The ATO publishes safe harbour interest rates each year under Practical Compliance Guideline PCG 2016/5. If your loan rate sits within the safe harbour range, the ATO accepts it as arm's length. If the rate is outside that range, you need to document why the rate is justified based on the property type, loan term, LVR, or other commercial factors.

If you're thinking about refinancing a related party loan to a commercial lender, or vice versa, the same compliance conditions apply. The loan has to be limited recourse, meaning the lender's rights in the event of default are restricted to the asset held in the trust and don't extend to other SMSF assets. Some lenders require a personal guarantee, and that's allowed, but the guarantee also has to be limited recourse to the asset.

Tax Treatment and Division 296 from July This Year

Rental income from a commercial property held in your SMSF is taxed at 15 percent during accumulation phase. If the property is supporting a pension and the fund's assets are fully segregated as pension assets, the rental income can be exempt. If the fund has both accumulation and pension interests, the exemption is partial and determined by an actuarial certificate.

Capital gains tax works the same way. If the property is held for at least 12 months, the fund may receive a one-third discount on the capital gain, which can produce a maximum effective rate of 10 percent. If the property is supporting a pension and the fund's assets are segregated, the capital gain can be disregarded entirely. The actual tax outcome depends on the property's cost base, selling costs, any capital works deductions claimed, and whether the fund has capital losses to offset.

Division 296 tax started on 1 July this year. If your total superannuation balance at the end of the financial year exceeds $3 million, you pay an additional 15 percent tax on the proportion of earnings above that threshold. If your balance exceeds $10 million, you pay an extra 10 percent on the portion above that amount. The thresholds are indexed annually. Division 296 tax applies to realised earnings, not unrealised gains. Rental income and capital gains from the sale of property count toward the Division 296 earnings base, but an increase in the property's value doesn't trigger Division 296 tax unless you sell.

LRBA amounts are disregarded when calculating your total superannuation balance for Division 296 purposes. If your SMSF owns a commercial property under a Limited Recourse Borrowing Arrangement, the outstanding loan amount is subtracted from your balance.

When the Property Doesn't Qualify as Business Real Property

A property marketed as commercial doesn't automatically meet the definition. If part of the building is used as a residence, or if the tenant uses part of it for private purposes, the property might not qualify as business real property. Mixed-use properties require careful assessment.

A primary production property with a dwelling on no more than 2 hectares can still qualify if the main use of the whole property is not domestic or private. That concession is specific to primary production and doesn't apply to other property types. If you're looking at a rural property near the Barossa Valley or the Fleurieu Peninsula and part of it includes a residence, you need to confirm whether the concession applies or whether the residential component disqualifies the property.

If the property doesn't qualify, you can't use an LRBA to buy it. You can still buy the property outright with your SMSF's cash, provided the property isn't acquired from a related party and no fund member or related party occupies it. But if you were relying on borrowed funds to make the purchase, the transaction won't proceed unless the property use changes or the residential component is removed.

If you're working through an SMSF loan application and the lender or your SMSF specialist flags that the property might not meet the business real property test, get clarity before you exchange contracts. Once you're committed to the purchase, your options narrow quickly.

Call one of our team or book an appointment at a time that works for you. We work with FIFO workers across South Australia and can connect you with SMSF specialists and lenders who understand how these structures work for people on roster.

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