Self-Managed Super Funds (SMSFs) are becoming a popular vehicle for investing in property. However, when it comes to making changes or improvements to that property, there are strict rules and regulations that must be followed. These rules are in place to ensure that the sole purpose of the SMSF — providing for your retirement — is upheld. In this article, we’ll outline what you can and can’t renovate when you own a property through your SMSF.
Understanding SMSF Property Rules
When investing in property through an SMSF, the Australian Taxation Office (ATO) has set guidelines on how the property must be managed and what is permitted in terms of renovations. Central to these rules is the sole purpose test, which means the SMSF must be maintained for the sole purpose of providing retirement benefits to its members. Any renovations that jeopardise this, or that provide an immediate personal benefit, are likely to breach this requirement.
It’s important to note that the rules around property purchased outright (with cash from the SMSF) differ from those bought with borrowed funds (an SMSF loan). Understanding these distinctions is crucial to avoid penalties.
The Golden Rule: No ‘Improving’
One of the key rules of using an SMSF loan to purchase property inside super is that you can’t improve the property. In simpler terms, you can maintain and repair the property, but adding something new or making it significantly better than it was originally is off the table.
Renovations on a Property Purchased with Cash (no SMSF loan used)
If your SMSF purchased the property outright without borrowing, you have far more flexibility in terms of renovations.
What You Can Renovate
For properties purchased without borrowing, you can make both repairs and improvements. Renovations that increase the property’s value or change its structure are allowed, as long as the sole purpose of the SMSF (providing retirement benefits) is still met. Examples of allowable renovations include:
- – Upgrading kitchens and bathrooms
- – Adding extra rooms or extending the property
- – Modernising outdated structures
- – Landscaping or adding outdoor living spaces
The key here is that because there is no borrowing involved, you are allowed to increase the property’s value through improvements, as long as the SMSF’s investment strategy remains in line with its original purpose.
What You Can’t Renovate
Even when a property is purchased with cash, there are still some restrictions. Members generally cannot use the property for personal purposes (such as living in it or letting family members live there). The renovations must also align with the SMSF’s investment strategy. For example, overly luxurious renovations that do not fit with the property’s intended use as a retirement asset could potentially breach SMSF rules.
Existing cash within your SMSF can be used to improve your SMSF property, however, these enhancements are not allowed to transform the asset into a different type of asset (for example, transforming land into property).
Renovations on a Property Purchased with an SMSF Loan
If your SMSF has borrowed money to purchase the property, the rules around renovations are much stricter.
What You Can Do
For properties purchased with borrowed funds, you are limited to repairs and maintenance. This means you can only restore the property to its original state or fix something that is broken. Examples of allowable repairs include:
- – Fixing a leaky roof
- – Replacing broken windows or doors
- – Repainting walls
- – Restoring damaged floorboards
These repairs are necessary to maintain the property and keep it in good condition without enhancing or significantly altering its value. Importantly, the repairs must not change the property’s nature or function.
What You Can’t Do
You are not allowed to make improvements or substantial renovations that increase the property’s value when borrowing is involved. This includes:
- – Adding new rooms or structures
- – Renovating the kitchen or bathroom beyond basic repairs
- – Installing a swimming pool or extensive landscaping
- – Changing the overall layout or functionality of the property
These improvements could be seen as changing the fundamental value or nature of the property, which is not allowed when the property has been purchased using an SMSF loan.
Understanding the Distinction: Repairs vs. Improvements
One of the most confusing aspects of SMSF property rules is the distinction between repairs and improvements. Here’s a clear breakdown:
Repairs
Repairs involve fixing or restoring something that is broken or worn out, returning it to its original condition. Repairs do not change the nature, character, or value of the property. Examples include:
- – Fixing plumbing issues
- – Replacing broken tiles
- – Repairing damaged fixtures
Improvements
Improvements go beyond repairs, adding new features or value to the property. Improvements enhance the property’s functionality or increase its market value, and they are not allowed on properties purchased with an SMSF loan. Examples include:
- – Adding a new bathroom or bedroom
- – Modernising a kitchen with new appliances and fixtures
- – Extending the property with additional living spaces
For properties purchased with borrowed funds, these improvements are strictly off-limits.
Common Mistakes to Avoid
Many SMSF trustees fall into traps when renovating SMSF properties. Some common mistakes include:
- – Confusing repairs with improvements: Even small improvements like installing modern fixtures can breach the rules if borrowing is involved.
- – Providing personal benefit: Using the SMSF property for personal use, such as renting it out to a family member or staying in it yourself, may be a breach.
- – Failing to maintain records: Not keeping proper documentation of renovation costs, repair invoices, and the rationale for repairs can lead to compliance issues.
Breaching these rules can lead to significant penalties, so it’s critical to stay within the guidelines.
Professional Advice and Compliance
Renovating an SMSF property can be a complex process, and getting it wrong can have serious financial consequences. For this reason, it’s essential to seek professional advice before undertaking any renovations. An SMSF advisor, accountant, or financial planner can help ensure that any work done on the property complies with ATO regulations and that you remain within the limits of SMSF law.
Renovating a property within your SMSF may be a way to maintain or enhance its condition, but only if done correctly and in line with ATO guidelines. Understanding the difference between repairs and improvements and the impact of borrowing on renovation restrictions is crucial. By adhering to the rules, seeking professional guidance, and maintaining compliance, you can protect your SMSF property and ensure it continues to support your long-term retirement goals.
If you’d like to chat further about SMSF loans for purchasing or renovating a property, please get in touch with us to discuss.
