Whilst married life may bring bliss and happiness, it’s unfortunate that many marriages do end in divorce. Divorce usually brings with it heartache and financial settlements. And the many members of Australia’s self-managed superannuation funds (SMSFs) are unfortunately not immune to either.
There are more than 1 million SMSF members nationwide who account for more than $540 billion in assets; therefore it should come as no surprise that the assets of an SMSF are often the next big-ticket item in any divorce proceeding after the marital home in any family law settlement.
Recent changes to superannuation law have provided members with the possibility of directly investing in lumpy assets such as leveraged property. This has compounded the problems couples face when dividing assets. But it needn’t be all thorns and devastation. Good outcomes can be created for both parties with a little communication and, in some cases, compromise.
The below case study is a prime example of how assets can be divided in an SMSF when a marriage breakdown occurs.
Tom and Sarah own a commercial property held within their SMSF and tenanted by the associated business of one of the SMSF beneficiaries. They are going through a divorce and have agreed upon a 50-50 asset split. They own their former marital home valued at $400,000 with no capital gains tax (CGT) issues to consider.
Sarah operates a small homewares business valued at $100,000 from a commercial property owned by their SMSF, which is valued at $300,000.
The business pays a commercial rent rate to the SMSF and the property is proving to be a great investment, having doubled in value since purchase while producing a strong rent yield.
Sarah leaves the marital home but keeps the business. Tom keeps the home and takes a $150,000 loan against it to pay out Sarah for her share of the two assets’ $500,000 joint value ($250,000 each).
The problems to the above situation arise when splitting the value of their $300,000 SMSF property.
Some possible solutions to these problems are:
Tom and Sarah can remain separately invested in their SMSF, remaining completely independent with separate account balances, independent asset and rental valuations, and independent audits of the SMSF’s financial accounts for added assurance.
This is often the best outcome but it does rely on some degree of goodwill between the parties. Sometimes this is not possible and a full separation of assets is required.
For example, if Sarah wishes to keep the SMSF property while Tom wanted his $150,000 balance rolled out into another superannuation fund, she could not in these circumstances borrow against the property or use a non-recourse loan to pay out Tom, as it is an existing SMSF asset.
But Sarah could find another investor to replace Tom. This could be a relative or a friend who pays out Tom’s share within the same SMSF or into another SMSF of which Tom is a member. This new investor does not have to be an SMSF member, but can be anyone or any other (separate) entity, as long as the property itself isn’t used to facilitate the investment. If Sarah doesn’t want to bring in other investors and needs to borrow, she will need to consider moving the property out of the SMSF.
Another option is for Sarah to make a non-concessional contribution of $150,000 to her SMSF to pay out Tom which, depending on her age, may be highly tax-effective.
Some of these approaches may raise questions of capital gains tax and transfer costs but, in some cases under family law, SMSF pensions and duties relief, the impact can be reduced to zero.
Finally, Sarah may want to sell the property with a longer lease-back to herself, protecting the business location and maximising the value of the sale, which may produce a better outcome overall.
The issues raised will mostly be the same if the property is residential, with the main exception being that you may not rent the property to yourself or to an associate.
When there’s a large SMSF asset involved, divorce requires co-operation from many sources. The couples involved, including their tax, legal and financial advisers must work together. However it is important to remember that the problems are not impossible to overcome.
For more information on SMSF or if you are interested in setting one up, contact us on 02 9299 7044 or via firstname.lastname@example.org.