Guide to SMSF Lease Agreements

Lease agreement

Wherever we have an SMSF that holds property, it is more than likely that the fund needs to have a valid, compliant lease agreement in place between the smsf trustee and the tenant.

Why is it the case that an SMSF must have a lease agreement in place? This almost appears to be an answer that has a lot to do with ATO compliance requirements moreso than a financial audit issue – of course, its nice to be protected by a lease and so, that also enhances financial accuracy in the reports.

Why must an SMSF Have a lease agreement in place?

Over the last 5-10 years or so, the ATO have been stepping up their messaging and enforcement of their duties as the co-regulator of smsf auditors. Those anywhere in an SMSF’s stakeholder pipeline who were not aware of this requirement, are now sure to be.

There is a specific section of the legislation known as SISA s.109 – Arms length Dealings which states that any transaction with the smsf is not knowingly allowed to be detrimental to an SMSF.

Here’s an accurate summary of s109:

A trustee must not invest unless they and the other party in relation to that transaction are dealing with each other at arm’s length – or – they are not dealing at arm’s length but the terms and conditions are no more favourable to the other party than if they were dealing at arm’s length.

And, I read the law around this as basically saying no matter what way it is looked at, that it comes back to at least appearing to be arm’s length – whether it is or isn’t.

Then we ask ourselves, what does an arm’s length transaction and dealing look like when it comes to real property leases.

What are some aspects around a leased property?

Typically, what we would expect to see when it comes to leased premises of an smsf consist of the following:

Rental Income – so income actually crediting the smsf’s bank account. This amount would be net of all expenses that the smsf incurs directly from the agent, any repairs, any rates and perhaps taxes amongst other things I may have missed here.

Rental Statement – ties into the above, your monthly statement from the agency net figure should match what the bank statement receives. The top of the statement is what the tenant pays you

Rental agreement – the binding agreement between tenant and smsf. Very important, and all tenancy arrangements must have these in place – leases outline the terms and conditions between parties. It is the rental agreement that sets not only the present but even medium length timeframes for terms such as amount, frequency, length, increases, continuation of any fixed term periods – and so these are especially important – at least in the eyes of the ATO. I will add that the terms must be consistent with that of someone who is unrelated, even if the smsf tenant is actually a related party.

You wont believe the amount of times I still get superannuation funds to audit where lease agreements are not on file, don’t exist, have expired or have the incorrect terms.

What are the important terms in a rental agreement?

Lease agreement – first and foremost – just having one, in writing and in a format consistent with what’s on the market for a comparable property.

Lease Amount – what does a comparable property get on the lease market at that point in time as a general rule. How do we know? It is usually the agent that determines this amount for an unrelated party – and even with a related party too, an agents report shows what the lease amount should be. It’s a good idea to organise this prior to leasing out the property and entering the amount on the agreement.

Payment frequency – Ideally monthly. Need an exceptional reason why it is anything other than monthly id say.

Length of agreement – typically 12 months but longer is appropriate too. Shorter can be fine. Its case dependent

CPI Increases / Fixed increases / Market reviews – are we seeing built in mechanisms for a lease to automatically increase along with cpi where the lease starts to appear longer than 12 months. On the anniversary of a lease, a cpi increase is appropriate. Where the increases are fixed, they need to resemble something like a CPI – reasonable. If market reviews are adopted annually – then evidence of this is required. An agent might provide another report 12 months on, and the new amount should be adopted.

Continuation clauses / Periodic – these are paragraphs written into the clauses section of many agreements that state that the lease continues at the same terms once the fixed period expires. Sure, there could be variations to this, but that needs to be expressed. If the continuation clause omits any specific adjustments to any other clause – then it is implied that the same terms carry forward. If this occurs – it is even more important for each and every term to appear arm’s length and future proof. Even with continuation clauses, I would think anything more than 3 - 5 years warrants a new lease if that lease is a shorter one of say 1 year or so. Sometimes a periodic continuation is written in addition to a continuation clause for nuanced guidance between parties.

Bond: 1 month rent or so

Rules and responsibilities: Details maintenance, notice, utilities, pets – and just about anything else.

Outgoings / Utilities: In commercial situations, these additional outgoing costs are borne by the tenant rather than the SMSF. The way this works is that its written where the tenant pays the base rent + agreed share = total rent (share can also be included in the total rent of all outgoings – as much as 100%). So, property outgoings (typically look like Council rates, water rates, owners corp fees, landlord building insurance) on top of their utility costs such as power and water.

In conclusion - Lease agreements form an important and required part of your annual audit where your smsf holds real property and your smsf auditor should be checking to see whether you have one, whether the terms are compliant now and in the future.