Beginner's guide to SMSF leasing and market rent

If you're operating a mobile plant on a mine site and thinking about using your super to buy commercial property, one option is leasing it back to a business you're involved with. The rule is simple: the rent must be at market rate.

That's not a suggestion from the ATO. It's a legal requirement under the Superannuation Industry (Supervision) Act. If the rent is below market value, your fund can be treated as holding an in-house asset, which has consequences, or worse, the arrangement might breach the sole purpose test entirely.

What counts as a related party lease

A related party is any person or entity connected to you or another member of your SMSF. That includes your employer, a business you own or control, a family member, a company or trust you're involved with, or a partnership you're part of. If your SMSF buys a warehouse using a Limited Recourse Borrowing Arrangement and leases it to your earthmoving business, that's a related party lease.

Business real property leased to a related party is excluded from the in-house asset rules, but only if the lease is made on arm's length terms at market value. If the rent is discounted or inflated, or if other lease terms aren't commercial, the arrangement may fail that test.

Why market rent is not optional

Market rent is the amount a tenant would pay in an open, arm's length transaction for a property of the same type, location, and condition. The ATO expects you to set rent based on what the property would achieve if it were advertised and leased to an unrelated tenant. If you charge less than that, even by a small margin, you're giving your business or related entity a benefit at the expense of your super fund. That's a breach of the sole purpose test, which requires your SMSF to be maintained solely to provide retirement benefits.

Consider a mobile plant operator who sets up an SMSF, borrows to buy a commercial shed, and leases it to a business they co-own. The property would ordinarily rent for around $50,000 per year based on local comparable leases. The operator charges $35,000 because the business is still getting established. The rent is below market, so the property may be classified as an in-house asset. That triggers a breach if in-house assets exceed 5 percent of the fund's total assets. The ATO may also treat the rental income as non-arm's length income, which is taxed at 45 percent instead of the usual 15 percent.

How to determine market rent

You need evidence. That means a formal valuation from a qualified property valuer, a rental appraisal from a licensed commercial real estate agent, or a comparison with similar properties leased in the same area at the same time. The evidence should be current and specific to your property type and location. A valuation done two years ago or in a different town doesn't satisfy the requirement.

The rent should be reviewed regularly, especially when market conditions change or when the lease is renewed. What was market rate 12 months ago might not be market rate now. If you're leasing a commercial property through your SMSF, you need to document how the rent was determined and keep records of the evidence you relied on.

What happens when rent is set wrong

If the ATO determines that rent is below market value, the income may be treated as non-arm's length income under section 295-550 of the Income Tax Assessment Act. That means the rental income is taxed at 45 percent instead of 15 percent. If the property is classified as an in-house asset and the total value of in-house assets exceeds 5 percent of your fund's total assets, you must prepare a written plan to reduce the excess to below 5 percent before the end of the following income year. If you don't, your fund may lose its complying status.

A fund that loses complying status is taxed at the top marginal rate on all its income, not just the non-arm's length portion. The consequences can wipe out years of tax concessions.

Leasing to yourself or a family member for residential property

You cannot lease residential property held in your SMSF to yourself, a family member, or any related party. The prohibition is absolute. Even if you pay above-market rent, even if you document everything, the lease is not allowed. Residential property in an SMSF must be leased to an unrelated tenant or left vacant. Business real property is the only type of real property that can be leased to a related party, and only if the lease is at market rate.

If you're considering a residential investment loan outside your SMSF, different rules apply. But inside the fund, residential leasing to related parties is banned.

Setting up the lease properly from the start

The lease agreement should be in writing and structured like any other commercial lease. It should specify the rent, payment terms, lease duration, outgoings, maintenance responsibilities, and any rent review clauses. The terms should reflect what an unrelated party would accept. If you're charging below-market rent or offering unusual concessions, the arrangement will not stand up under scrutiny.

Before the lease is signed, get a valuation or rental appraisal and keep it on file. Update it when the lease is renewed or if market conditions shift. If the ATO audits your fund, you'll need to show how you determined the rent and that it was reasonable at the time.

When to talk to someone who knows the rules

SMSF property transactions carry legal, tax, and compliance obligations that go beyond a standard home loan or investment loan refinance. If you're setting up a Limited Recourse Borrowing Arrangement to buy business real property and lease it to a related party, you need advice from a licensed SMSF specialist and a broker who understands how lenders assess these structures. The loan itself must meet the limited recourse requirements, the holding trust must be set up correctly, and the lease must be at market rate. Miss one part of that and the whole arrangement can fall over.

Call one of our team or book an appointment at a time that works for you.

Frequently Asked Questions