SMSF in-house assets: how the 5% rule works in practice

The in-house asset rules are one of the SIS Act's main guardrails between an SMSF and the people who run it. Get the 5% test wrong and the fund either has to sell assets at the worst possible time, or face penalties and possible loss of complying status.

What is an in-house asset?

An in-house asset is any of the following held by the SMSF:

• A loan to, or investment in, a related party of the fund
• An investment in a related trust of the fund
• An asset of the fund subject to a lease or lease arrangement with a related party

'Related party' is broad — it includes members, their relatives, and entities (companies, trusts, partnerships) those people control. There are limited exclusions, the most important being business real property leased to a related party at arm's-length terms.

The 5% limit

Section 83 of the SIS Act caps the market value of in-house assets at 5% of the total market value of the fund's assets. The test is applied at the end of every financial year (30 June) and at the time of any new acquisition.

Two different breach situations

Trustees can fail in two ways:

• Acquisition breach: acquiring an in-house asset that, taken with existing in-house assets, would push the ratio over 5%. This is prohibited outright by section 84.
• Year-end breach: at 30 June, the ratio of in-house assets to total fund assets exceeds 5% — typically because other assets fell in value, not because the trustee bought anything.

What you must do if you breach the 5% rule at 30 June

If the ratio exceeds 5% at year end, the trustees must prepare a written plan before the end of the next financial year setting out which in-house assets will be disposed of to bring the ratio back to 5% or less, and the plan must actually be carried out. The plan and supporting trustee minutes need to be kept on file for the auditor.

Common situations to watch

• Loans to a member's family business — these are in-house assets and tightly capped
• Investments in a unit trust where members or relatives also hold units
• Residential property leased to a related party — almost always a problem
• Business equipment owned by the fund and used by a member's company

Source: Australian Taxation Office — In-house assets, sections 71–85 of the SIS Act (ato.gov.au). Independent advice is recommended before any related-party transaction.