Today’s article is not about how the SMSF buys the property – we are talking about how the SMSF leases the property to a related party.  In essence, you follow the same rules that you would follow if you were leasing the property to any member of the public.

This is not an occasion to save costs by cutting corners.  Any cost saving could end up being expensive and painful.

The Leasing Rules:

1. A market rate of rent to be paid
2. A written lease to be in place
3. Rent to be paid in accordance with the lease terms
4. If rent isn’t paid, the SMSF to enforce the terms of the lease

Some SMSF Trustees don’t pay enough attention to these rules.  If you don’t, the SMSF Auditor may have to take action – an experience to avoid!

It is “understandable” (but absolutely no excuse) that where you control both the Landlord and the Tenant, you might not treat the Lease paperwork with the same degree of care and attention.

What to do?

1.  Market rent to be paid

A market rate of rent must be paid by the Tenant to the SMSF.   You can’t decide what the market rental should be.  You need to obtain an independent assessment of the rent from someone capable, experienced and familiar with the market.  In other words, you need a written valuation from a Valuer or a written market appraisal from a real estate agent.

The amount of rent must be reviewed every year to ensure that the current market rent is paid each and every year.  It is not a set and forget scenario.

An annual CPI increase during the term of the lease (often a 3 year term) will usually satisfy your obligations.

Where the lease is renewed for another 3-year term, you will need to repeat the process that you undertook prior to the commencement of the lease and obtain another valuation or written market appraisal.

The amount of rent payable each year should be confirmed in writing between the Landlord (SMSF) and the Tenant (You, your company or trust).

2.  Written lease to be in place

You need to prepare a commercial lease agreement and a lawyer should be engaged for this purpose.

The terms and conditions of the Lease need to protect you (the SMSF) as the property owner at all times – meaning now at the commencement of the lease, and later in circumstances where you sell the business and are no longer the tenant.

When the time comes to sell the business, the SMSF may want to retain ownership of the premises, and continue to receive a rent payment every month.

Benefits of a properly prepared Lease

By having a proper lease in place from the outset:

1. You save legal costs by preparing a comprehensive Lease once (and doing it well), rather than a budget lease now & a comprehensive lease later,
2. You can ensure that the Lease is drafted to enable land tax to be recovered from future tenants after the business has been sold,
3. there is one less thing to worry about when selling the business,
4. increased likelihood that the SMSF Auditor will be satisfied that there has been compliance with the rules.
5. when selling your business, the Buyer will review the Lease as part of its due diligence > a properly prepared Lease will give confidence to the Buyer that they have security of tenure over the premises.

The Lease is to be prepared like all other “arm’s length” commercial leases – detailing:

• the lease commencement date,
• the length of the lease,
• the options to extend the lease for additional terms,
• how & when rent payment are to be made,
• who is responsible for the outgoings of the property,
• how annual rent adjustments are calculated,
• how market rent reviews are conducted when a new lease term is agreed

3.  Rent to be paid in accordance with the lease

Once the Lease has been signed and the Lease commences, the rent payments must be made as stated in the lease – for the correct amount and by the due date.

Higher rent can’t be paid to benefit the SMSF, nor can lower rent be paid to benefit the Tenant.

Outgoings will also be payable, in accordance with the lease terms.  Where the rent includes an amount for outgoings, this amount would need to be allowed for when determining the market rent.

4.  If rent isn’t paid, the SMSF to enforce the lease

If rent isn’t paid as required by the lease terms, the SMSF trustee needs to enforce the lease as any Landlord would in similar circumstances.

Therefore, the usual process of letters of demand, notices to remedy breach etc must be pursued in accordance with the law, until such time as the Tenant has complied with its obligations.  There is no point in examining these enforcement obligations as it would be unproductive and a waste of valuable resources for the rent payments to remain unpaid.

Final Comment

The SMSF Trustee needs to follow the rules when leasing business real property to a related party.  The Trustee needs to remain mindful that rules can change, and therefore must keep itself informed as to any rule changes.

Having the Lease documents available, and all supporting documentation on hand will make the annual audit process much easier.  You want to make the auditor’s job as simple and straightforward as possible.

Disclaimer: The above is to be considered as general education. This is not advice and it is not to be acted upon without advice from a qualified professional who understands your personal circumstances.

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