Too often we see simple mistakes made by trustees when acquiring vacant land. Getting it wrong can have major consequences.
The first stuff up is when they acquire the land from a related party; the second is when that land is acquired using borrowings under a s.67 compliant LRBA; and the third is borrowing to fund the construction on that land!
Related Party stuff up –
The trustees of a self-managed superannuation fund (SMSF) are prohibited from intentionally acquiring an asset from a related party of the fund, except for assets permitted under s.66(1) of the SIS Act.
Under s.66(2) of the SIS Act the trustees can acquire property from a related party of the fund, providing it is considered “Business Real Property”. So, is vacant land ‘business real property’?
Business real property must satisfy two tests to meet this definition.
The first test – the property must be considered “real property”. Real property is:
Any freehold or leasehold interest.
Any interest of the entity in Crown land, other than a leasehold interest, being an interest that is capable of assignment or transfer.
A demountable placed on land would not qualify as it is not real property in its own right.
So, given a freehold or leasehold interest is included within the definition of real property, it can be determined that land satisfies this definition.
The second test – does the land satisfy the “business use test”. For this to be satisfied the property must be “wholly and exclusively used in one or more businesses to the exclusion of other types of use”.
The term “wholly and exclusively” means:
Used to an appreciable degree; and
A ‘minor’ or ‘trifling’ part of the property may not be used at all.
As you would imagine, in most circumstances vacant land would not satisfy the business use test and is therefore unable to be acquired from a related party. However, there are circumstances where the business use test would be satisfied. This includes:
Vacant land held for development purposes may be regarded as business real property where used as part of a land development business.
Vacant land which is used in a business would qualify as business real property (e.g. primary production land, car park).
Temporarily vacant land on which commercial premises are constructed will remain business real property, even where the premises are currently unleased, provided the property is simply ‘between leases’ and the owner has not abandoned their plans to lease the property [SMSFR 2009/1 para 227 to 228]. Similarly, the business use of the property must not be simply ‘transitory or temporary’.
Now on to the second common mistake:
LRBA stuff up –
Let’s now assume the SMSF has insufficient funds and is looking to acquire the vacant land using an LRBA. In order to borrow under an LRBA, s.67 of the SIS Act states that the asset to be acquired must be a “single acquirable asset”. In most cases, the fund has a green light to make the purchase.
But here’s where things go sideways… The trustees then look to build a dwelling on the land that was acquired via a LRBA, which in most cases will change the nature of the asset post construction which is a breach of s67 of the SIS Act. Ruling SMSFR2012/1 sets out the rules around changing the nature of an asset acquired under a s.67 LRBA.
Now the third ‘oversight’ when buying land:
“But I want to build” –
Often trustees buy vacant land to build either commercial or residential freehold. BUT, they sometimes assume they can borrow and put the land up as security to do so.
This is a no no. Regardless of whether a pre-existing loan exists over the land via a LRBA or not, s.67 only allows for borrowings for the acquisition of a single acquirable asset. Construction does not meet this definition. So, now the fund is left with vacant land that cannot be developed until the fund has enough cash to do so. Borrowing to construct under an LRBA is out!
To make things worse, often the trustees look to use a Related Party Builder.
Remember, under s.66 of the SIS Act the trustees of the SMSF cannot acquire assets from a related party unless it meets one of the permitted exceptions.
SMSFR 2010/1 covers this scenario and explains the circumstances preventing the use of a related party builder. We trip over with the RPB supplying materials as each item is an asset which fail the s.66 permitted exceptions.
However, there is scope for a related party builder to be used, however, the arrangement would require the related party builder to act as an “agent” when supplying the materials to the fund.
It would be recommended to obtain specialist SMSF legal advice if this were something trustees wanted to explore.
The message – ASK your Accountant or Advisor BEFORE you go and buy vacant land (or any asset for that matter). Always ask:
Who am I buying the vacant land from?
Will I build on the land and change the nature of the asset?
Do I need to borrow at ANY stage?