Can an SMSF acquire an asset which is mortgaged?

Yes, according to a recently released Interpretative Decision – ATO ID 2011/81.  However, there are limits to this Decision.

The ATO addressed the question of whether an SMSF trustee breaches SIS Reg 13.14 if the trustee purchases a property which is subject to a charge?  The answer was “No”.

The reasoning provided in the Decision is that the prohibition set out in SIS Reg 13.14 is a prohibition against the trustee giving a change over or in relation to an asset of the fund.  Purchasing an asset which is already subject to a charge is not giving a charge over the purchased asset.  The ATO concluded that the prohibition is directed against the trustee creating a charge rather than a trustee recognising an existing charge.

While the factual question asked in the Decision was in relation to a purchase of a mortgaged asset for market value from an unrelated party, it seems that the reasoning would apply to a gift of an asset.  Further the reasoning, it seems, would apply to a situation where the charge arises in respect of the asset after acquisition – for example, where the charge arises by reason of law or by Court decision – so long as the trustee does not create the charge.

The ATO in the Decision noted that the question posed simply related to the operation of SIS Reg 13.14.  In any acquisition of an asset by an SMSF trustee there are other SIS issues to be considered: in particular, whether the acquisition breaches the sole purpose test or whether the acquisition amounts to the provision of financial assistance to a member or relative.

It is interesting to speculate as to the consequences of the following scenario: a member gifts their currently bank mortgaged property to their SMSF; the member subsequently pays off the secured debt and then discharges the mortgage.  It would seem that the significant increase in value of the asset, due to the discharge of the mortgage will accrue to the SMSF in a manner which is not caught by the contribution cap rules.  There are obvious issues which would have to be considered including other SIS provisions, the deemed contribution rules and any relevant anti-avoidance provisions.