SMSF Commercial Loans & Market Rent Requirements

When you buy commercial property through your SMSF and lease it back to your law firm or a related entity, the lease must be at market rent.

This requirement protects the fund's retirement purpose and ensures compliance with the arm's length provisions under superannuation law. The rent you charge cannot be below market value, even if reducing the rent would benefit your practice's cash flow or allow you to reinvest more into the business. The sole purpose test under section 62 of the SIS Act requires that every decision about the SMSF asset, including the terms of any lease, must prioritise the fund's retirement benefit objective over any present-day advantage to you or your firm.

Why Market Rent Applies to Related Party Leases

Business real property leased between an SMSF and a related party is excluded from the in-house asset rules, but only if the lease is made on arm's length terms at market value. The exclusion exists because business real property already satisfies the definition under section 66 of the SIS Act, which permits the fund to hold and lease assets used wholly and exclusively in a business. That exclusion does not remove the requirement for the lease itself to reflect what an unrelated tenant would pay in the same circumstances.

Consider a litigation practice that purchases its office premises through the partners' SMSF using a limited recourse borrowing arrangement. The fund acquires the property via a bare trust structure, and once settlement occurs, the law firm enters a lease with the SMSF trustee. If the partners set the rent at $80,000 per year when comparable premises in the same building lease for $110,000, the arrangement contravenes the arm's length requirement. The ATO may treat the shortfall as a non-arm's length expense, which can result in the fund's income being taxed at the top marginal rate rather than the concessional rate that applies to complying super funds. The lease terms, including rent, must reflect what would be negotiated between parties dealing at arm's length.

How Market Rent Is Determined

Market rent is the amount a willing but not anxious tenant would pay a willing but not anxious landlord for the premises, assuming both parties are dealing independently and have reasonable knowledge of relevant facts. This is not the same as the rent your firm currently pays, the rent you would prefer to pay, or the rent that would make the investment return meet a particular target. The determination requires a formal valuation or evidence of comparable leases for similar properties in the same location.

A valuer will assess factors including the size and configuration of the premises, the quality of the fit-out, the location and accessibility, the lease term and options, and the outgoings arrangement. In most commercial leases, the tenant is responsible for outgoings such as rates, insurance, and maintenance, but the structure of these responsibilities affects the net rent. If your firm occupies the entire building and the lease is structured as net, the market rent will differ from a gross rent arrangement where the landlord retains responsibility for outgoings.

In a scenario where a three-partner litigation firm acquires a 300-square-metre office in a suburban commercial precinct at the current median for that asset class, the firm must obtain a rental valuation before entering the lease. The valuer identifies three comparable leases within 500 metres, all executed within the past 12 months, with rents ranging from $350 to $380 per square metre net. The valuer assesses the subject property as consistent with those comparables and determines a market rent of $105,000 per year plus GST plus outgoings. The firm cannot justify a lower rent by arguing that it would have negotiated a discount as a long-term tenant, or that the fit-out was funded by the partners and should reduce the rent. The lease must be documented at the market rate, and the rent must be reviewed in line with the lease terms, typically annually by a fixed percentage or according to CPI.

Documentation and Ongoing Compliance

The lease must be documented in writing and executed before the related party takes possession. The ATO expects the lease to include standard commercial terms, including the rent amount, the frequency of rent reviews, the responsibilities for outgoings and maintenance, and any options to renew. If the lease is not documented or if the terms do not reflect arm's length dealing, the fund may contravene both the sole purpose test and the in-house asset rules, even though business real property is ordinarily excluded from those rules.

Rent reviews are a common compliance failure. If the lease specifies an annual CPI review but the trustee does not implement the increase, the rent falls below market and the arrangement is no longer arm's length. The trustee must review the rent according to the lease terms and, if the lease provides for a market review, obtain an updated valuation at the review date. Many leases include a ratchet clause that prevents the rent from decreasing, but this does not remove the obligation to assess the market rent at the review date and apply the outcome according to the lease terms.

Business Real Property Definition and Mixed-Use Considerations

The market rent requirement applies specifically to business real property as defined under the SIS Act. The property must be used wholly and exclusively in one or more businesses. Whether a property satisfies this definition is a question of fact based on actual use, not the description in a contract of sale or the zoning. A property marketed as commercial does not automatically qualify, and a property that includes a residential component or is used partly for private purposes may not meet the definition at all.

Mixed-use properties require particular attention. A building that contains both office space and a residential apartment does not satisfy the wholly and exclusively test unless the residential component is incidental and falls within a specific exception, such as the primary production dwelling concession, which does not apply to commercial office property. If the property does not qualify as business real property, the fund cannot acquire it from a related party at all, and any lease to a related party would be treated as an in-house asset subject to the 5 per cent limit. The definition is set out in detail in SMSFR 2009/1, and trustees should obtain specific advice before proceeding if there is any question about whether the property qualifies.

What Happens If the Rent Is Not at Market

If the ATO determines that the rent is below market value, the fund may be treated as receiving non-arm's length income. Under the non-arm's length income provisions, any income derived by the fund as a result of a non-arm's length arrangement is taxed at the top marginal rate rather than the concessional rate that applies to complying super funds. The shortfall in rent can be treated as a non-arm's length expense, meaning the rental income the fund does receive is taxed at the higher rate.

The trustee may also contravene the sole purpose test if the below-market rent provides a present-day benefit to the member or the related party. A contravention of the sole purpose test can result in the fund losing its complying status, which has significant tax consequences including the loss of concessional tax treatment on contributions and earnings. The ATO has discretion to impose administrative penalties, and in serious cases, the trustee may be disqualified. The compliance obligation is ongoing, and it is not sufficient to set the rent at market value at the start of the lease and then ignore it. The rent must remain at market value throughout the term of the lease, and the trustee must act to adjust the rent when reviews fall due.

If you are considering acquiring commercial premises through your SMSF or you currently lease property from your fund to your practice, obtain a formal rental valuation from a qualified valuer with experience in commercial property in your location. Document the lease in writing before taking possession, and implement rent reviews according to the lease terms. If you are using a limited recourse borrowing arrangement to fund the acquisition, the lender will require evidence that the lease is at market rent as part of the serviceability assessment, but the compliance obligation extends beyond the lender's requirements and continues for as long as the fund holds the property and the related party remains in occupation.

Call one of our team or book an appointment at a time that works for you to discuss how an SMSF commercial loan structures for your circumstances and what documentation you will need to satisfy both lender and compliance requirements.

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