Self-Managed Super Funds are able to borrow to buy an asset under what is known as a Limited Recourse Borrowing Arrangement (LRBA).
There are many benefits to buying an investment property with SMSF borrowing but there are certain conditions that must be met prior to borrowing, and specific rules on how the arrangement must be structured:
- Borrowed money must be used to purchase a single acquirable asset, e.g. one property or a parcel of (identical) shares in a single company.
- Borrowed money can be used to pay expenses such as repairs or maintenance of the acquired asset.
- Borrowed money can NOT be used to improve the asset (e.g. renovate an investment property).
- The asset must be held in a custodial trust with the SMSF having a beneficial interest in the asset. The trustee of the custodial trust cannot be the same as the trustee of the SMSF (see our guide on How SMSF Property Loans Work)
- The SMSF trustee must have the right to legal ownership of the asset once the loan has been repaid.
- If the SMSF defaults on the loan, the lender will only have recourse to the asset purchased with the borrowed money (and not other assets of the SMSF).
- Once the loan is repaid, it can’t be redrawn again to fund other asset purchases.
Before entering into an LRBA the SMSF trust deed must be reviewed to ensure the SMSF is permitted to borrow. The SMSF investment strategy should also explicitly permit SMSF Borrowing.
Frequently Asked Questions
What is a Single Acquirable Asset? (or Collection of Identical Assets)
Each loan can only be used to buy a single asset. This means for example, that a property spread across more than one title deed is usually not a single asset. The acquisition of each title would need to be financed from a separate loan arrangement. An exception to the rule is where a property covers more than one title but it is legally impossible to sell them separately or there is a permanent and substantial fixture that is built across the titles.
A collection of assets will meet the rules for a single asset if the assets are identical, have the same market value and are purchased in one transaction. For example, a parcel of shares in a single company can be purchased provided they are all at the same price.
Can I Buy ‘Off the Plan’?
Yes, it is possible to purchase a property ‘off the plan’ using an LRBA. You need to ensure the SMSF pays the deposit using savings and the loan is used to finance the balance of the purchase price at settlement.
Can my SMSF Renovate an Investment Property?
Yes, but not with borrowed money. SMSF Borrowings can only be used for purchase, repairs and maintenance, not for improvements.
What is the Difference between Maintenance/Repairs and Improvements?
Maintenance is defined as work to prevent defects, damage or deterioration to the asset while repairs include remedying or making good an asset. E.g. replacing carpet or installing a new bath tub is most likely to be maintenance as there is no change to the nature and character of the asset.
Improvements change the state or function of the asset and usually involve substantial alterations for the better. E.g. the addition of a second storey to a house is likely to be an improvement as the nature of the asset is changed.
See ATO Ruling SMSFR 2012/1EC for more detail on improvements vs repairs.
Advice should be sought before money is spent on an asset that is subject to an LRBA.
What does ‘limited recourse’ mean?
The loan must be limited recourse. If the SMSF trustee defaults on the loan the lender can only recover what is owed from the asset that was purchased with the loan. This protects the other assets in the fund. In practice, most lenders require SMSF Trustees to provide personal guarantees as part of the SMSF Loan application.
What is a Holding Trust? (or Bare Trust or Custodial Trust)
The asset being purchased with the LRBA must be held on trust for the SMSF. The title should be registered in the name of the holding trust. This will be different to the trustee of the SMSF.
The Holding Trust does nothing other than holds the asset on trust for the SMSF while there is a loan attached to the asset. Once the loan is repaid, the asset can (but doesn’t necessarily have to) be transferred to the SMSF. Legal advice is needed at this time to ensure the transfer doesn’t result in unnecessary Stamp duty.
SMSF Borrowing can be a useful strategy when used properly. Professional advice is essential before going down this path.
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Disclaimer: This post has been prepared for general information purposes only. It is not specific advice to any particular person. You should consult an authorised Align Financial adviser before making financial decisions. Align Financial | Financial Planner Northern Beaches | Servicing North Narrabeen, Narrabeen, Mona Vale, Elanora Heights, Newport, Avalon, Palm Beach | Enquire with us online.