A common problem in Family Law Superannuation Splitting is how to split an interest in a self managed superannuation fund (SMSF) where the fund owns a commercial property.
The husband and wife own a self managed superannuation fund (SMSF). The SMSF holds a business real property worth around $400,000 and some cash of about $1,000. The husband’s business (a company) leases the property from the superfund. The draft property orders propose that the superannuation is to be split 50/50 and the wife would transfer her interest to a fund of her choice. The dilemma is that the superfund does not have enough cash to pay the wife without selling the commercial property. However, if he sells the property, the business will be severely disrupted.
It has been a common practice for some time for businesses to put their business premises into their SMSF and then the business leases the property from the fund. One of the problems with this approach is that the equity in the property is tied up in the superfund and cannot be accessed for additional borrowing by the company.
The question is: how can the husband keep the property and at the same time pay out $200,000 to the wife from the SMSF?
What he CANNOT do
The Superfund cannot borrow against the existing property. Whilst SMSF’s can borrow as a limited recourse loan to purchase a new property, it cannot borrow against the existing property.
Generally speaking, the SIS Act prohibits superannuation funds from borrowing money. A SMSF is also prohibited from using its assets as security.
There are a few exemptions available, namely: short-term borrowing to finance the member’s benefit payments, short-term borrowing to bridge investment transactions, and limited recourse loans. However, none of the exemptions applies in this case.
What he CAN do
Option 1: The husband can make non-concessional contributions (personal after-tax income contributions) of up to $450,000 into the SMSF if he is less than 65 years old. He can make a $200,000 cash non-concessional contribution to the SMSF and the SMSF can then use the cash to pay out the wife and can keep the property.
No tax deduction is available to the husband for the contributions. No income tax will be paid by the SMSF on the contribution received. The practical issue for the husband is how to get the bank loan if he does not have enough equity in his own name.
Option 2: If the husband is over 50, the company (his business) can make $50,000 concessional contributions for him to the SMSF. The rest ($150,000) can be financed by non-concessional contributions.
Any interest expenses on the borrowing by the company to finance the contributions are deductible to the company. The company can also claim the $50,000 contributions made to the SMSF. However, the $50,000 will be taxed in the hands of the SMSF at 15%. This option also reduces the personal financing burden for the husband.
Option 3: Bring in a new member. The new member’s benefits can be brought in either by way of rollover from another fund or by way of contributions, provided both the husband and the wife as the trustees of the SMSF agree to bring in a new member. The SMSF can use the cash from the new member to pay out the wife. In exchange, the new member will have his interest in cash exchanged for interest in property for the same value. The practical issue is where to find the right person who is willing to put his retirement savings with the husband and is willing to pay $200,000 for half the interest in the property.
Option 4: The SMSF can sell the property to a trust controlled by the husband. The property would be leased by the company from the trust. Whilst the property could be sold to the company, there are CGT issues when the property is later sold if it is held in the company. However, the property was put into the SMSF for asset-protection purposes and if the company/trust owns the property, it makes the property available to creditors if the business fails. Stamp Duty costs would also need to be considered. The optimum structure will differ for each person and it would take into account financing, income tax, the level of debt, capital gains tax, stamp duty and the future needs of the husband.
Option 5: The husband sets up a new SMSF as the sole member. The new SMSF purchases the property from the old SMSF using a limited recourse loan. As the acquisition is business real property, the new SMSF is allowed to acquire the property from a related party and the property is exempt from being an in-house asset of the new SMSF. The SIS act allows limited recourse loans. The old SMSF could use the cash from selling the property to pay out the wife. The remaining cash can be rolled into the new SMSF by the husband and used to pay back half of the limited recourse loan. This option is the most complex, most expensive and riskiest option. It requires a competent accountant to oversee the whole transaction. Other factors like market valuation of the property should also be considered. Any mistake could lead to the SMSF becoming non-compliant. Effectively it could strip the husband of the property, as 50% of the property goes to the wife and the other 50% could go to the ATO.
We would love to hear your thoughts – leave your question or comment below: