The 5% in-house asset test is one of the most important compliance obligations for SMSF trustees. In-house assets include any loan to a related party, any investment in a related party (such as an equity stake in a related party company), and any asset leased to a related party. At each balance date (typically 30 June), the trustee must calculate the total value of in-house assets as a percentage of total fund assets, both measured at market value. This percentage must not exceed 5%.
Importantly, the 5% is calculated against the gross value of the fund’s assets, not the net value. This is a common source of confusion for trustees, particularly where the fund has borrowed under a limited recourse borrowing arrangement. If the fund holds $1 million in assets and has a $600,000 LRBA loan outstanding, the 5% is measured against the gross value of $1 million, not the net equity of $400,000. The outstanding borrowing does not reduce the asset base against which the 5% is tested. This means that a fund with significant borrowings has a larger dollar threshold for in-house assets than a trustee might expect if they were thinking in terms of net equity.
If in-house assets exceed 5% at 30 June, the trustee must prepare a written plan setting out how the fund will reduce in-house assets below 5% by the following 30 June. This plan is not lodged with the ATO but must be retained in the fund’s records and be capable of production to the auditor. The plan should be realistic and detailed, showing specific actions (such as disposal of an asset or repayment of a loan) and target dates. If the fund fails to reduce below 5% by 30 June of the following year, the trustees contravene the in-house asset provisions (civil penalty provisions, sections 82–85 of the SIS Act), exposing them to administrative penalties and, in serious cases, the fund to a non-complying determination.
The 5% test is applied at two points: immediately after any in-house asset is acquired (section 83) and at 30 June each year (section 82). Before acquiring an in-house asset, the trustee should therefore recalculate the percentage; if the acquisition would take the fund over 5%, it must not proceed unless other in-house assets are disposed of at the same time. Similarly, if the fund receives a contribution of an asset that is in-house (such as an in-specie contribution of shares in a related company), the 5% test applies. This requires careful monitoring and planning whenever the fund considers acquiring in-house assets or receiving contributions.
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