SMSF Renovation Disaster

SMSF Renovation Disaster: Alex and Cheryl, who are medical practitioners, have narrowed down their choice to two investment properties for purchase within their SMSF. The first is an existing commercial property, valued at $1.2 million, that currently serves as an accounting practice. The second is a residential property located at a busy road corner, which could be converted into a commercial property with the council's approval, at a cost of $2 million.

SMSF Renovation Disaster

Both properties would require a minimum of $300K in renovations to be suitable for a GP practice. Alex and Cheryl have enough cash to cover 50% of the deposit, stamp duty, legal fees, etc., and they intend to finance the remaining amount. After learning about the significant improvement rules, they reached out to Investax for a clearer understanding of how these rules apply.

Challenges –

  1. The property will be purchased under Limited Recourse Borrowing (LRBA) arrangement.
  2. Potential renovation cost to change from the accounting practice set up to a GP Practice.
  3. Significant change may change the status of Single Acquirable asset.

Solutions –

Under subparagraph 67A(1)(a)(i) of the Superannuation Industry (Supervision) Act 1993(SISA), borrowings under an LRBA cannot be used to fund improvements. Money from other sources can be used to improve (or repair or maintain) a single acquirable asset. However, any improvements must not result in the acquirable asset becoming a different asset. A 'single acquirable asset' refers to an investment property/asset that, even after renovations, retains its fundamental characteristics and remains recognisable as the same asset initially purchased. Extensive modifications that transform its core features or purpose could reclassify it as a distinctly different property in the eyes of regulatory bodies.

They have enough surplus fund in their SMSF to take care of the renovation for both properties.

Commercial Property – On the basis that there are no significant changes to the nature of the property i.e., it is still used as a commercial property, the improvements will not cause the commercial property to become a different asset.

Residential Property – There are several conditions trustees must comply with that determine whether improvements to a fund’s asset constitute a fundamental change to that asset.

Where the fundamental nature of the property has changed either from residential to commercial or by the addition to, or fit-out of, the property, it is important to establish if the change has resulted in a different asset.

In this case, the asset is being changed from a residential property to a commercial property. As there are significant changes to the fundamental nature and use of the property, updating the premises in this case would clearly cause the property to become a different asset.

Action Plan for the readers:

  1. Assessment of Renovation Costs:
    • Start by obtaining detailed quotes and estimates for the renovation costs required to transform the investment property into a GP Practice.
    • Ensure that you have a clear understanding of all the expenses involved, including construction, permits, interior design, and any necessary equipment or technology for the medical practice.
  2. Review Surplus Funds:
    • Confirm the surplus funds available in your Self-Managed Superannuation Fund (SMSF) to cover the renovation costs for both properties.
    • Ensure that the surplus funds are sufficient to complete the renovation without the need for borrowing under an LRBA.
  3. Consult with your accountants:
    • Continue your communication with your accountants to gain a comprehensive understanding of the rules and regulations regarding significant improvements under subparagraph 67A(1)(a)(i) of the Superannuation Industry (Supervision) Act 1993 (SISA). It is better to have a specialised property or SMSF accountant to deal with type of arrangements.
    • Seek clarification from your accountant on how the renovations would impact the status of the single acquirable asset if you would like to do a significant renovation for your SMSF properties.
  4. Residential Property Transformation:
    • Changing a residential property into a commercial one involves significant changes in its fundamental nature and use. It will be a violation of the act if there is an LRBA arrangement in place.
    • Consult with a legal or financial advisor to understand the implications of such a transformation on the status of the asset within your SMSF.
    • Consider seeking a ruling or clarification from the Australian Taxation Office (ATO) regarding the specific circumstances of this transformation.
  5. Documentation and Compliance:
    • Maintain thorough documentation of all financial transactions related to the renovation.
    • Ensure that you comply with all SMSF regulations and reporting requirements throughout the renovation process.
  6. Professional Guidance:
    • Consider consulting with a financial planner or SMSF specialist accountants who has experience with similar cases to provide personalized guidance and expertise throughout the process.

If you find yourself facing similar challenges or have questions about your SMSF property journey, don't hesitate to reach out to us at Investax Group. Our experienced team is here to provide you with personalized guidance and expertise to help you navigate your unique situation and achieve your investment goals. Your success is our priority, and we look forward to assisting you on your SMSF property investment path.