In-house assets and the 5 per cent rule explained

One of the rules that catches SMSF trustees out is the limit on what are called in-house assets. In short, your fund can only have a small amount of its money tied up with people and businesses connected to you. This article explains what an in-house asset is and how the 5 per cent limit works.

What is an in-house asset

An in-house asset is broadly an investment in, or a loan to, a party connected to your fund, or an asset of the fund that is rented to a connected party. A connected party means the members, their relatives, and businesses or trusts they control.

So examples of in-house assets include lending the fund’s money to a company you own, investing the fund’s money in a family trust, or renting a fund asset to a business connected to you.

The 5 per cent limit

The rule is simple to state: in-house assets cannot be more than 5 per cent of the total value of your fund. If your fund is worth a certain amount, the value of all its in-house assets added together cannot exceed 5 per cent of that.

This limit is tested at two points. It is tested when the fund buys an in-house asset, so you cannot acquire one that takes you over 5 per cent. And it is tested again at the end of each financial year, on 30 June.

What happens if you go over

There are two situations to understand.

If you go over the limit because the fund buys an in-house asset it should not have, that is a breach straight away, and your auditor may have to report it.

If you are over the limit at 30 June because of changes in value rather than a new purchase, for example because your other investments fell while the in-house asset held steady, you must put a written plan in place to sell enough in-house assets to get back under 5 per cent, and carry that plan out in the following year.

The important exceptions

Some dealings with connected parties are exempt from the in-house asset rules, which is why they are allowed even though they involve a connected party.

The main exception is business property rented to a connected business on full commercial terms. If your fund owns the premises your own business operates from, and the business pays full market rent, that is generally exempt.

There is also an exception for certain investments in connected trusts or companies that follow strict conditions, such as not borrowing and not running a business. These exceptions are valuable but fragile: if the connected entity breaks even one of the conditions, the exemption is lost permanently, and the whole investment suddenly counts as an in-house asset, which usually pushes the fund well over the limit.

Why it matters

The limit exists to stop super funds being used mainly to prop up the members’ own businesses and ventures, rather than being invested for retirement. Breaching the limit is a common contravention, and because the exceptions can fail suddenly, a fund can go from compliant to well over the limit in a single step if a connected entity breaks its conditions.

The bottom line

Your fund can have only a small amount, up to 5 per cent of its value, tied up with people and businesses connected to you. The limit is checked when you buy and again at year end. Business property rented to your business on full commercial terms is the main exception, and the exceptions for connected entities can be lost permanently if their strict conditions are broken. If your fund deals with anyone connected to you, keep a close eye on this rule.

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This article is general information for trustees and members. It is not financial, legal or tax advice about your particular situation. Consider getting advice from a licensed professional before making decisions about your fund.