Why Should Market Rent Apply When Leasing SMSF Property

Self-managed super funds that own commercial property often lease that asset to a business controlled by a member or a related party. The arrangement is permitted under the Superannuation Industry (Supervision) Act 1993, provided the property meets the definition of business real property and the lease is made on arm's length terms at market value.

Market Rent Protects the Fund From Non-Arm's Length Income Tax

Any lease between an SMSF and a related party must charge rent at market value. Where the lease terms are not consistent with what unrelated parties would agree to in an open market transaction, the ATO may treat the income as non-arm's length income (NALI). NALI is taxed at 45 percent rather than the concessional rate of 15 percent that applies to ordinary SMSF rental income. The tax penalty applies to the entire rental income stream from the property, not just the shortfall between actual rent and market rent. A below-market rent arrangement that saves a member's business $10,000 per year in rent could result in the fund paying an additional $30,000 or more in tax annually, depending on the total rental income received.

How Market Rent is Determined for Business Real Property

Market rent is the amount a willing but not anxious tenant would pay a willing but not anxious landlord for a comparable property in the same location under similar lease terms. Determining market rent for commercial property requires a formal valuation or rental appraisal from a qualified property valuer with experience in the relevant asset class. Desktop valuations or estimates based on advertised listings are not sufficient for SMSF compliance purposes. The valuation should account for the property's location, size, condition, improvements, access, visibility, zoning, tenant fit-out, lease term, options, outgoings, and any other factors that influence rental value in that specific market. For a warehouse in Beenleigh's industrial precinct near the Pacific Motorway, relevant comparables would include similar facilities with equivalent access, clearance height, hardstand area, and office component. A retail shopfront on George Street would require separate analysis based on foot traffic, exposure, neighbouring tenancies, and car parking availability.

When to Obtain a Rental Valuation

A rental valuation should be obtained before entering into any lease with a related party and reviewed at each lease renewal or rent review date specified in the lease agreement. Where the lease provides for annual CPI adjustments without market review, a fresh valuation should still be obtained at intervals not exceeding three years to confirm the rent remains consistent with market movements. In some commercial sectors, market rents may move independently of CPI due to supply, demand, economic conditions, or changes in the local area. Consider a scenario where an SMSF owns a small warehouse leased to a member's freight business at $35,000 per annum with annual CPI increases. After five years, surrounding properties have been rezoned and similar warehouses are now leasing for $50,000 per annum due to increased industrial demand in the Beenleigh and Yatala corridor. The fund is undercharging by $15,000 annually, the member's business is receiving a non-commercial benefit, and the entire $35,000 rental income could be classified as NALI and taxed at 45 percent.

Lease Terms Must Also Reflect Arm's Length Conditions

Market rent is one component of an arm's length lease. Other terms must also align with what unrelated parties would agree to, including the lease term, rent review mechanism, outgoings, options to renew, security deposit, maintenance obligations, and termination provisions. A lease that charges market rent but includes non-commercial terms such as a 20-year lease term with no rent reviews, unlimited options to renew at the tenant's discretion, or a termination clause allowing the tenant to exit without penalty at any time would not satisfy the arm's length requirement. The ATO examines the substance of the arrangement, not just the rent figure documented in the lease.

Business Real Property Must Be Used Wholly and Exclusively in a Business

For business real property to qualify under section 66 of the SIS Act, the property must be used wholly and exclusively in one or more businesses. The business does not need to be conducted by the fund, but the property must not be used for any domestic or private purpose. A property marketed as commercial does not automatically meet the definition. The actual use at the time of acquisition and throughout the holding period determines compliance. A mixed-use property that includes both commercial and residential components may not qualify in full, or at all, depending on the specific facts. Guidance in SMSFR 2009/1 provides detailed examples and should be reviewed before acquiring any property intended to be treated as business real property. Properties in Beenleigh's older commercial zones along the main road may include an attached dwelling that was previously used by a former business owner. Where that dwelling is leased separately or used for private purposes, the property may fail the wholly and exclusively test.

In-House Asset Exemption Depends on Compliance

Business real property leased to a related party is excluded from the in-house asset rules, which would otherwise limit the fund's investment in related party assets to 5 percent of total fund assets. This exemption only applies where the property genuinely satisfies the definition of business real property and the lease is maintained on arm's length terms. If either condition fails, the property may be classified as an in-house asset. Where the value of in-house assets exceeds 5 percent of the fund's total assets, the trustee must prepare a written plan to reduce the excess to below the threshold before the end of the following income year. Failing to rectify a breach can result in penalties and potential disqualification of the fund's complying status.

Documentation and Record Keeping Requirements

Trustees must retain evidence that the lease was entered into on arm's length terms and continues to satisfy that requirement. Documentation should include the initial rental valuation, subsequent valuations at each review date, a written lease agreement signed by all parties, evidence that rent has been paid in full and on time, and records of any lease variations or renewals. The ATO may request this evidence during an audit or review. In our experience, many related party lease arrangements are undocumented or rely on outdated valuations. A lease that was at market value five years ago is not automatically compliant today without current evidence.

SMSF Loans and Related Party Leasing After the 2026 Changes

From 10 August 2026, new limited recourse borrowing arrangements can only be used to acquire business real property, not residential property. SMSFs that own commercial property under an SMSF loan and lease that property to a related party must continue to meet all compliance conditions, including market rent and arm's length lease terms. The borrowing does not change the requirement for arm's length dealing. Where a property is held under a Limited Recourse Borrowing Arrangement with a holding trust structure, both the SMSF trustee and the trustee of the holding trust should be parties to the lease or otherwise documented to reflect the beneficial interest held by the SMSF. Legal advice should be obtained to confirm the lease structure is consistent with the LRBA and holding trust deed.

Charging below-market rent to a related party may feel like a reasonable arrangement between family members, but the tax consequences can be severe and the compliance risk extends beyond the immediate income year. Call one of our team or book an appointment at a time that works for you to discuss how we can assist with structuring your SMSF commercial loan and connecting you with licensed SMSF specialists who can review your lease arrangements and rental valuations.

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