SMSF Series 4 - Buying Property with Loan (Limited Recourse Borrowing Arrangement)

SMSF loan lets you borrow the funds in your SMSF to purchase an investment property. any rental income or capital gains from the property are reinvested, and can only be accessed at retirement.

SMSF Loan - Limited Recourse Borrowing Arrangement (LRBA)

SMSFs are generally not allowed to borrow money under the Superannuation Industry (Supervision) Act 1993 (SIS Act) but under very strict conditions, the superannuation regulations allow an SMSF to borrow, that is LRBA. Simply, the LRBA limits the ability of the lender to only access the property and not the fund’s other assets in the case of a default by the fund. A separate property trust (i.e. a Bare Trust) is established to hold the property on behalf of the fund. The Bare Trust does not trade, receive rent or pay any expenses. The fund is responsible for loan repayments, receiving rent and paying rental and borrowing expenses.

The structure explained above is summarised in the following diagram.

Generally, when a borrower defaults on loan repayments, the lender often has access to a range of borrower's other assets as recourse. However, with LRBAs, if the SMSF defaults, the lender’s recourse is strictly limited to the property that the SMSF loan was used to purchase.

Establishing a Holding Trust (i.e. Bare Trust)

The holding trust is also commonly referred to as custodian trust or bare trust. Its purpose is to hold legal title to the property. It is not an operating trust and therefore doesn’t lodge a tax return or have any assets such as a bank account. The holding trust merely holds legal title to the property during the time the loan is in place. All transactions in relation to the property occur on the SMSF bank account.

The holding trust is established by a separate trust deed. The trustees can be either a company or one or more individuals. However, the holding trustee cannot be the same entity (individuals or company) as the SMSF trustee.

Rules of LRBA Investing

Borrowed money can only be used purchase a single acquirable asset: If the SMSF wants to purchase more than one asset, it will need to take out a loan for each separately.
The loan can only be used to purchase the property: It cannot be used to improve, renovate, or maintain it.
The asset will be held in a separate bare trust: The SMSF trustee will have a beneficial interest in the trust but not legal ownership of the asset while it is being paid off.
The SMSF trustee has the right to take over legal ownership when the loan is repaid.
The SMSF loan must only be used to acquire a property. Funds cannot be used to improve or alter a property’s structure. Any property maintenance and other related expenses must be financed using other funds from within the SMSF.

Factors to Consider

The major banks have stopped approving SMSF loans, but they are still available from some banks and other lending institutions.
SMSF property loans tend to be more costly than other property loans as lenders consider them to be higher risk. The lender will need to be satisfied the fund will have the cash flow to service the loan repayments, allowing for current and future retirement pension payments or lump sum withdrawals.
An SMSF generally needs to have a minimum balance of $180,000 to be able to purchase a property.
You would need to make an annual personal super contributions to your SMSF of at least $15,000 in addition to super contributions made by your employer. This additional contributions would be required to satisfy solvency of your SMSF and lender's cash flow requirements.
Banks often charge a higher rate of interest on a loan obtained by your SMSF.
There are restrictions for an SMSF to do renovations beyond repairs and maintenance.

Options after Loan Term

When the property is sold, the proceeds will pay off any outstanding amount owed on the loan and any other associated costs. Any leftover will go to the SMSF.

Upon the Fund’s repayment of the limited recourse loan, the SMSF Trustees have the option of acquiring title to the asset directly. The legal title of the property can be transferred from the holding trustee (Bare Trust) to the SMSF trustee, and if structured correctly there should be no tax, capital gains or stamp duty consequences. The trustee may decide for the title of the investment to remain in the holding trust without breaching the borrowing rules.

If you have further questions, please contact us (https://www.goodpca.com.au/contact-us).

Disclaimer

This content is intended as a general guide for GOOD PEOPLE ACCOUNTING SERVICES clients. The information is general in nature and does not take into account your personal situation. You should consider whether the information is appropriate to your needs, and where appropriate, seek professional advice. Although every effort has been made to verify the accuracy of the information contained above, GOOD PEOPLE ACCOUNTING SERVICES disclaim all liability (except for any liability which by law cannot be excluded), for any error, inaccuracy in, or omission from the information contained on this website or any loss or damage suffered by any person directly or indirectly through relying on this information.