Many self managed superannuation funds (SMSFs) invest in residential property. With finer weather on the way and holiday breaks coming up, a lot of people start to think about renovating these properties – especially if a property is not producing much income. But with the law being quite strict on what you can and cannot do with properties held in SMSFs, it might be enough to put you off taking any action or making any decisions.

Whether you can renovate a property held by your SMSF depends on whether the property was purchased by your SMSF outright with money accumulated in the SMSF or whether it was purchased using money borrowed.

Properties purchased with borrowings

If the SMSF’s property was purchased using borrowed money and the borrowing remains outstanding, then you are restricted from using the borrowed funds to renovate, and thereby improve, the property. You can only use the borrowed fund to make repairs to the property.

The difference between a “repair” and an “improvement” is that a repair includes work to restore the efficiency of function of the property without changing its character. It merely replaces or corrects a part of the property that is already there and has become worn out or dilapidated through ordinary wear and tear, or is damaged accidentally or by natural causes.

An improvement, on the other hand, is work that provides a greater efficiency of function in the property and usually involves bringing the property into a more valuable or desirable form, state or condition. A property would be considered improved if the state or function of the property is significantly altered for the better, through substantial alternations, or the addition of further substantial features to the property.

Now, you can use money already accumulated in your SMSF to improve a property purchased by your SMSF via borrowings, as long as the improvement does not result in the property becoming a different type of asset. For example, you could add a swimming pool or extension of two bedrooms to the property and the property would still be a residential premise. That is okay.

But if the residential home is converted into a restaurant through renovations which may include fitting out a fully functioning commercial kitchen, then that would not be okay when borrowing is involved.

Properties purchased with accumulated funds

If the SMSF’s property was purchased using money accumulated in the SMSF, then there are no restrictions in renovating the property. You could even demolish the property and build a new property or properties on the land owned by your SMSF. But what you do need to be careful of is that firstly, your SMSF’s investment strategy allows for such actions; and, secondly you don’t do the work yourself unless you are licensed and qualified to do the work required and you provide these services to the general public through your business.

If you are in the building and renovation business, then it is also important that any materials used in the renovation are purchased by your SMSF directly from third parties and not from you directly. This is because your SMSF is restricted from acquiring building materials from you. You need to make sure that any labour provided by you is paid by your SMSF at the commercial rate. Otherwise, the increase in the market value of the renovated property owned by your SMSF may be treated as a personal superannuation contribution and may result in you exceeding your contributions caps.

Just remember, if your SMSF has a loan on the property and is using borrowed money to fix it, you are limited to making repairs. If your SMSF has a loan on the property but is using its own money for the renovations, you can renovate a property to improve it as long as you don’t change its character. If your SMSF owns the property outright and is using its own money on the property, you can improve and change the character of the property.

Posted by Monica Rule – Money Manager (Fairfax) on 5th November, 2014