You have built a reasonable super balance, you want property in the mix, and an SMSF feels like the right structure. The numbers look sensible. The strategy makes sense on paper. Then someone mentions the sole purpose test, and the question becomes: what actually is it, and why do so many otherwise careful trustees fall foul of it?
What the rule actually says
The sole purpose test sets the primary and ancillary purposes for which a superannuation fund must be operated: to provide benefits to members after their retirement, on reaching retirement age, or on their death. The test is in section 62 of the Superannuation Industry (Supervision) Act 1993.
Every investment or management decision made by SMSF trustees must be consistent with this sole purpose. The intention is to ensure trustees make decisions that are in the best retirement interests of their members, not their current interests or those of related parties.
There is no tick-a-box form to pass. There is no formal test for trustees to pass. It is a legal compliance guide the ATO can apply to fund transactions and the decision-making of trustees if necessary.
The ATO's ruling on this area, SMSFR 2008/2, makes clear that the standard is one of exclusivity, not merely dominant intent. Complying with the sole purpose test requires an "exclusivity of purpose", above what would be a "dominant or principal purpose".
Where property investors most often get it wrong
Property is the most common flashpoint. The specific scenarios the ATO flags are practical ones that many trustees would not immediately register as a breach.
A contravention can occur if the asset provides a pre-retirement benefit to a related party, such as holidaying in your SMSF investment property, or if the fund invests in collectables such as art or wine and a trustee, member, or related party displays or stores these assets in their private residence.
An example of breaching the sole purpose test is where an SMSF invests in a rental property specifically to allow a related party to live in that property. That covers not just trustees but their relatives. A residential property held by an SMSF cannot be lived in by fund members or relatives. It can be rented to unrelated third parties only.
The most common sources of breach, according to the ATO, are "investments that offer a pre-retirement benefit to a member or associate" and "providing financial help or a pre-retirement benefit to someone, to the financial detriment of your fund".
A common misunderstanding among small business owners is to treat their SMSF like a personal fund they can dip into when their business is going through a rough patch. Some SMSF trustees may also be tempted to help family members with a loan from fund money, or cheap rent in a property owned by the fund. Both scenarios can and do result in breaches.
It is also worth noting that auditors are actively looking. It is a legal requirement for SMSFs to be audited each year by an independent auditor. SMSF auditors check that all the fund's transactions are consistent with its trust deed and investment strategy. They must ensure compliance with all super legislation including the sole purpose test. Any potential legislative breaches must be reported by the auditor to the fund trustees and the ATO.
The consequences, and they are serious
The ATO has a graduated set of responses, but even the lighter end of the scale involves real cost and administrative burden.
Serious contraventions of super laws may result in an SMSF being issued with a notice of non-compliance. In this case, the fund remains non-compliant until it receives a notice of compliance. Making a fund non-complying can have a significant financial impact because it does not qualify for concessional tax rates, so its assessable income is taxed at the highest marginal tax rate, which is currently 45%, in the year it becomes non-complying.
At the more serious end, the current maximum civil penalty is 2,400 penalty units, which relates to a maximum penalty of $751,200. Trustees can also be personally disqualified. Disqualification means they can no longer be members of the SMSF, nor can they start a new fund.
The ATO notes that if a breach is serious enough, a fund can be made non-complying and could lose almost half of its assets in tax.
For context on how often this arises: while the vast majority of SMSFs comply with the sole purpose test, a significant minority have not heeded the message. According to the ATO's SMSF statistics, the sole purpose test represented 10.3% of total contraventions by SMSFs in the year to June 2023, up almost 10% in two years. It remains the fifth biggest source of contraventions by type.
A scenario to make it concrete
Consider a couple, call them David and Karen, who set up an SMSF and use a Limited Recourse Borrowing Arrangement (LRBA) via a bare trust to buy a three-bedroom investment property for $750,000. The property is tenanted by an unrelated party at a market rent confirmed by an independent rental appraisal. Rental income flows into the SMSF. Expenses are paid from the SMSF account. The fund is in accumulation phase, so rental income is taxed at 15% inside the fund. The arrangement complies.
Now change one fact: their adult daughter moves in at reduced rent while she saves a deposit. That single change is a breach. If any super fund transactions or decisions are deemed by the ATO to provide significant, non-incidental, direct or indirect financial benefit to fund trustees, members or related parties before retirement, the trustees are in breach of the sole purpose test. The daughter is a relative of a member. The benefit is direct and not incidental. The fund's complying status is at risk.
The fix is not simply to remove the daughter and move on. The auditor is obliged to report the contravention, and the ATO can take action even after a breach has been rectified. The penalties imposed are based on considerations such as the compliance history of the trustee, willingness to rectify the breach, seriousness of the breach, and the period over which the breach occurred.
Documentation of trustee decisions matters too. Trustees must be able to show why they made an investment decision or undertook a specific activity. Documenting the trustee's reasons in a minute or as part of the investment strategy can be very useful evidence for SMSF auditors.
What to do before you act
The sole purpose test is not a reason to avoid SMSF property. It is a reason to go in with the right structure, the right professionals, and clear documentation from day one.
- Get an SMSF specialist accountant involved before you sign anything. The investment strategy, trust deed, and LRBA structure all need to reflect the retirement-purpose framing that the ATO expects. An SMSF specialist accountant is the right starting point.
- Use an independent rental appraisal, every time. Renting at market value to an unrelated tenant, supported by a documented appraisal, is how you demonstrate arm's-length dealing. Below-market rent to a related party is one of the most frequently flagged issues.
- Speak with a licensed broker who understands SMSF lending. LRBA loans carry their own compliance requirements separate from the sole purpose test, the bare trust structure, loan terms, and documentation all need to be correct. A broker experienced in SMSF lending can coordinate that side.
If you want to understand how property inside an SMSF fits alongside other structures, the team at Elite Wealth Creators coordinates property sourcing and finance referrals for SMSF investors. You can read more at /services or book a call to talk through your situation.
General information only, not personal financial advice. Speak with a licensed adviser before acting.