1.0 Audit Procedures for Real Estate in SMSF
1.1 Review the Investment Strategy Document: Ensure the investment strategy permits the investment in real estate and adequately addresses the investment issues such as cash flow, investment diversity risk and reduced liquidity.
1.2 Ensure Title to the real estate is beneficially held by the Fund. Proof of title may be obtained in a number of ways. These include rental agent statements, rate notices from local council authorities, purchase contracts and solicitors purchase statements. A property title search need only be sought where other evidence is inconclusive.
1.3 Ensure the transactions for the period have been correctly recorded, for completeness and accuracy. For example, make sure rental receipts for the whole year have been brought to account, for council rates make sure all four quarters have been included and so on.
1.4 Review expenditures to ensure repairs have been properly identified and added to the cost base if they are improvements. Expenditures are improvements if:
1.4.1 They are significant repairs undertaken in the first year of ownership
1.4.2 A depreciable asset has been replaced, such as air conditioning or carpet.
1.4.3 A whole kitchen or bathroom has been renovated
1.4.4 An extension has been made to the property
1.5 Ensure the rent received and all expenses are on commercial terms, especially where property is being leased to a related party. Note there is considerable discretion with the impacts of COVID 19 on rental arrangements for the 2020 and 2021 years.
1.6 Investigate for any benefits to members and ensure only permitted benefits received. See separate FTB for procedures for holiday homes.
1.7 Substantiate the valuation of the real estate for adequacy and reasonableness and currency. Real Estate must be shown at market value every year end. We require that the trustees provide a market valuation or an updated assessment of the market valuation for every audit. Market valuations are always a high risk area for the audit. The amounts of valuations are often material and the means of determining market values is not always clear.
1.8 A market valuation is adequate if the basis of determining the market value has been adequately documented. Where a qualified person, such as a real estate agent or valuer has prepared the valuation, then a higher level of audit review is permitted. We need be less concerned with seeking evidence that the valuation is reasonable. However, the trustees may determine the market value. If the trustees have determined the valuation, we must obtain additional evidence and seek assurance that the valuation is reasonable.
1.9 A market valuation is reasonable if it makes sense with other evidence available to the auditor, and the documentation supporting the Trustee valuation must be sighted. A minute of the trustees, on its own, is not adequate support a valuation.
1.9.1 The valuation should give a gross or net rental return that is in line with market expectations; or
1.9.2 The valuation should be in line with sales of comparable properties. We will accept valuations from public data bases such as ‘RPData’ to support a valuation.
1.10 If the valuation of the property does not appear reasonable then we should seek further evidence to support the market value and address the potential error as an audit adjustment. Where we are still unable to obtain sufficient evidence consideration should be given to qualifying the Independent Audit Opinion and the lodgment of an ACR.
1.11 Ensure no charge has been taken over the property, except as permitted by LRBA exemption.
2.0 Temporary relief for COVID 19 for commercial rents
The ATO has announced it will not be taking compliance action for the 2020 and 2021 financial years where an SMSF provide rent relief to a related party business leasing commercial property from the fund. So if your business has a lease agreement with your SMSF for it’s premises / property being forced to pay market rent at while being impacted by Coronavirus is one less thing for business owners to worry about.
3.0 Is the rent at commercial terms?
We may request evidence to show the rental income received by the fund is paid on commercial terms, such as
3.1 Annual Rental Income & Expenses Schedule from your real estate management agent covering the lease of the property during the year.
3.2 Lease agreement organised via a real estate agent or other written lease agreement (see Is your SMSF leasing commercial property: Tips and traps).
3.3 Rental appraisal by an independent real estate agent (especially for related party transactions)
3.4 Supporting evidence such as For Rent listing or tenants notice to end contract and an explanation from the trustees if no rental income was received during the year
4.0 Why SMSF property investments must be revalued?
There are four main reasons why SMSF trustees need to revalue any real estate investments held by their fund:
Pensions – when a SMSF commences a pension, the value of the underlying investments that support that pension need to be determined to accurately calculate the minimum and maximum pension amounts.
Performance – it is essential for SMSF members and trustees to be able to measure the performance of their investments – which needs to include any change in the valuation of real property.
In-house Assets – SMSFs are limited to having 5% of their assets invested into ‘in-house’ assets. For this ratio to be accurately measured, all investments of the fund must be valued at fair market value.
Contribution Caps –To accurate determine whether the lower cap will apply, all assets of the SMSF need to be accurately valued at market value.
5.0 Who can undertake the valuation?
5.1 When it comes to obtaining the actual valuation of a property, it does not always need to be done by an independent valuer. It is not so much who does the valuation – rather how the valuation is performed which is the key factor in determining whether the valuation can be relied upon by the auditor or not.
5.2 Valuations can be conducted by:
Independent valuers
Real estate agents
Other unqualified persons (including trustees of the fund)
5.3 From an auditors perspective, something from an independent party holds a lot more weight than something from a trustee of a SMSF.
5.4 The method of determining market value – the ‘how’ is significantly more important than who conducts the valuation. The methodology must be objective, based on a reasonable process, take into account all relevant factors and be able to be explained to a third party.
5.5 For example, when determining the valuation of property, the following factors would be considered:
the value of similar properties
how much was paid for the property
valuations for council rates purposes
independent appraisals
rental yield
5.6 For SMSF trustees wishing to complete their own valuations, for residential properties they should obtain either a Street Sales History report or a Suburb Sales History report from RP Data. These reports are significantly cheaper than a full independent valuation, and they can form the basis for the valuation of the SMSF property – especially when combined with information freely available from RealEstate.com.au and similar sites.
5.7 When it comes to commercial, industrial and other more unique properties that a SMSF can hold as part of its investment strategy, it becomes more complex. The above historical RP Data reports may provide some helpful information, however more detailed analysis will normally be required to obtain a valuation that will be accurate enough to satisfy the auditor.
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