SMSF Commercial Loans & Business Real Property Rules

The business real property definition under the Superannuation Industry (Supervision) Act determines whether your SMSF can acquire property using borrowed funds.

Business real property means land and buildings used wholly and exclusively in one or more businesses, with limited exceptions for dwellings that occupy no more than 2 hectares where the main use is not domestic or private. The property's actual use at the time of acquisition determines whether it qualifies, regardless of what you intend to do with it later.

Consider a fund trustee looking at a warehouse unit in Malaga's industrial precinct. The property has been leased to a manufacturing tenant for the past three years. The business in which the property is used does not need to be carried on by the entity holding the interest in the property. The warehouse qualifies as business real property because it is used wholly and exclusively in the tenant's business, even though the SMSF will own it and the tenant operates independently.

Why the Business Real Property Definition Matters for SMSFs

The business real property definition is an exception to both the in-house asset rules and the related party acquisition rules under the SIS Act. This exception allows your SMSF to lease commercial property to a related party, such as a business you own or control, without breaching in-house asset limits. Any such lease must be made on arm's length terms at market value.

For Morley-based trustees with a family business operating from commercial premises, this distinction creates an opportunity to hold the business premises in the SMSF while leasing it to the operating entity. The rental income flows to the fund, and the property remains outside the in-house asset calculation provided it continues to satisfy the business real property definition.

The Sole Purpose Test and Commercial Property

The sole purpose test requires that your SMSF is maintained for the sole purpose of providing retirement benefits to members or their dependants. Every decision you make as trustee must align with this requirement. Acquiring commercial property through an SMSF loan satisfies the sole purpose test when the property is acquired as an investment to generate income or capital growth for the fund.

The test is breached when a member or related party gains a present-day benefit that is not incidental to the fund's retirement purpose. Leasing business real property to a related party at market rent does not breach the sole purpose test because the arrangement is commercial and the fund receives proper value. Leasing the same property at below-market rent to provide a subsidy to the related party would breach the test.

What Happens When Property Use Changes

Whether a property satisfies the business real property definition depends on its actual use at the time of acquisition. A property that qualifies at acquisition may lose that status if its use changes. A commercial warehouse converted to residential storage units would no longer be used wholly and exclusively in a business. The property would then become an in-house asset if leased to a related party.

For properties held under a limited recourse borrowing arrangement, a change in use does not affect the validity of the existing loan structure, but it does affect compliance with the in-house asset rules and may trigger related party acquisition prohibitions if the change in use is implemented by a related party.

Vacant land not currently used in a business and mixed-use properties where the main use is domestic or private may not qualify. A block of vacant industrial land in Morley zoned for commercial development does not satisfy the definition until it is actually used in a business. An SMSF cannot use borrowed funds to acquire vacant land under a limited recourse borrowing arrangement unless the land is already being used wholly and exclusively in a business at the time of acquisition.

How the Single Asset Requirement Applies

The borrowed money must be used to acquire a single asset or a collection of identical assets with the same market value that can be treated as a single asset. Multiple real property titles cannot be acquired under a single LRBA. An exception applies where the properties are distinctly identifiable as a single asset, meaning they are identifiable, have equal market value, and are bought and sold together.

In a scenario where a trustee wants to acquire two adjoining strata-titled office suites in a Morley commercial complex, each suite is on a separate title. Even if both suites are leased to the same tenant and managed as a single tenancy, they cannot be acquired under a single limited recourse borrowing arrangement unless they have equal market value and are sold together as a package. Properties on separate titles do not qualify even if substantially similar. The fund would need to acquire each suite separately using existing fund assets or establish two separate loan arrangements.

Refinancing an Existing SMSF Commercial Loan

Refinancing of commercial property loans held under a limited recourse borrowing arrangement remains available. Compliance conditions continue to apply, including that the refinanced loan must relate to the same single acquirable asset, maintain the limited recourse character of the original arrangement, and meet arm's length terms consistent with PCG 2016/5.

Under the ATO's existing position, a significant change to the terms or conditions of an LRBA ends the arrangement and a new one begins. Circumstances that may end an existing arrangement include refinancing that is inconsistent with the original arrangement, borrowing to acquire an asset not contemplated under the original arrangement, and changes to the ultimate beneficiaries of the arrangement. Switching lenders or adjusting the interest rate within the scope of the original arrangement does not create a new arrangement, but adding additional borrowings to fund capital improvements would.

Arm's Length Terms and Safe Harbour Rates

The ATO publishes safe harbour interest rates for SMSF LRBAs under PCG 2016/5. These rates are updated annually and provide a benchmark for determining whether loan terms are consistent with commercial arrangements. Income from an arrangement that does not meet arm's length terms may be assessed as non-arm's length income and taxed at the highest marginal rate.

For a commercial property loan with a loan-to-value ratio of 70 percent, the safe harbour rate provides a threshold above which the ATO will not challenge the arrangement on arm's length grounds. Borrowing from a related party at a rate significantly below this threshold exposes the fund to the risk that rental income will be treated as non-arm's length income and taxed accordingly. This also applies where the fund borrows from an unrelated lender but a related party provides a guarantee on terms that are not commercial.

Call one of our team or book an appointment at a time that works for you to discuss whether a commercial property acquisition fits within your SMSF strategy and complies with the business real property and sole purpose requirements.

Frequently Asked Questions