A deferred purchase instalment strategy is one way SMSF’s can add a direct business property to their  portfolios.

Following changes announced in this year’s Federal Budget, self-managed super fund (SMSF) trustees may need to consider alternative strategies when adding a direct business property to their portfolios.

A deferred purchase instalment strategy is also known as a vendor finance arrangement or a terms contract. It involves an SMSF paying a deposit based on a commercially determined value for a property, followed by regular instalments with a financing charge until the purchase price is paid in total.

Traditional finance is available to an SMSF subject to finance restrictions. Lenders often require a far higher deposit which can place property acquisition beyond the reach of many SMSF’s. Vendor finance does not have the same restrictions, therefore, provides greater flexibility.

Because the ATO does not view the strategy as borrowing the legal restrictions are less onerous. This makes it an attractive option for those who want greater flexibility to pay for the property over a period of time.

It also allows members to improve a property, which is not possible under other financing arrangements.

However, the complexity of the arrangement often lies in managing the cash flow of the fund within a commercial timeframe. This strategy is not for the unsophisticated investor, as certain rules need to be followed. Members need to be aware of the capital gains tax implications involved as the property is technically sold by the member or an entity they control to the SMSF – incurring a capital gain.

SMSF auditors generally will examine the purchase contract closely – in particular, the term period in which payments will be made. Members need to ensure there is a copy of the current title and a copy of change of ownership when the final payment is made.

Trustees need to ensure the property meets the definition of a business property, transactions are performed at arm’s length and an independent valuation of the property is conducted. The investment of a business property must be consistent with the SMSF’s investment strategy and the trust deed must allow the strategy.