Limited Recourse Borrowing Arrangements (LRBA)

A General Information Page When Borrowing To Purchase A Property With Your SMSF.

Disclaimer:

This webpage is only intended to be general in nature and the appropriateness will be dependent on each individuals circumstances. This information is provided as an information service only, and therefore, does not constitute financial product advice and should not be relied upon by any person whatsoever as financial product advice. None of the information provided takes into account your personal objectives, financial situation or needs. You must determine whether the information is appropriate in terms of your particular circumstances.

For financial product advice that takes account of your particular objectives, financial situation or needs, you should consider seeking financial advice from an Australian Financial Services licensee before making a financial decision.

The information provided is not ‘financial product advice’ as defined by the Corporations Act. We are not licensed to provide financial product advice or taxation advice. You should consider seeking advice from an Australian Financial Services licensee and/or a Qualified Taxation Accountant before making any decisions in relation to a Financial product or Taxation implication

Allan Pearson is suitably qualified to give both Credit Advice (Authorised Credit Representative 523250 of Australian Credit Licence number 392611) and Property Advice (Qld LREA 4336779).

How Your SMSF Can BORROW To Purchase Property

Limited Recourse Borrowing Arrangements (LRBA)

SMSF + Bare Trust Borrowing Structure

How Your SMSF Can Borrow To Purchase Property

A SMSF borrowing involves obtaining a loan from a bank, or a related party, and together with the SMSF’s existing funds purchasing a property, which is either a commercial or a residential property.

But I thought you couldn’t borrow money with your super?

SMSFs are not permitted to borrow except under very specific circumstances. One circumstance is a “Limited Recourse Borrowing Arrangements” (LRBA).

These arrangements get their name as the lender’s recourse; or rights to recover from a defaulted loan, are limited solely to the property which was used to secure the mortgage. Meaning that any other retirement savings accumulated within the SMSF are protected from the lender.

In contrast normal mortgages are full recourse, meaning that on default if the sale of the property does not cover the outstanding loan amount the bank can pursue other assets.

This is why a ‘standard’ home loan is not applicable and only a specific type of loan can be made. This can lead to fewer loan providers – which has its drawbacks.

What do you need to do to be legal (compliant)?

In addition to a specific loan type, a specific ownership structure must be established.

The property needs to be held on trust for your main SMSF account; meaning an additional related trust structure needs to be established to isolate this asset from the other assets in the SMSF. This separate trust will hold the legal title of the property on behalf on the SMSF. This trust structure is referred to as a ‘Bare Trust’ or Holding Trust.’

At all times this "Bare Trust" must hold only 1 Asset.

How does a Bare Trust / Holding Trust work?

A trust is a legal arrangement where an asset is managed for the benefit of another. A Bare Trust / Holding Trust is a simplified version of a trust and does not complete a tax return or hold a bank account - all the reporting requirements are handled by the SMSF.

The Bare Trust / Holding Trust holds the title for the property (legal ownership) of the property for the benefit of the SMSF (beneficial rights ownership). The SMSF receives the rent and any capital gains from the property.

The structuring and timing of establishing the Bare Trust / Holding Trust and its interaction is vital in ensuring compliance with the borrowing rules as well as avoiding negative stamp duty and capital gain implications.

Advantages of borrowing within your SMSF

  • Boosting retirement savings - By borrowing your Fund can acquire exposure to assets which the Fund previously could not afford. Allowing you to potentially achieve your retirement goals sooner.
  • Asset Protection - Superannuation assets are generally protected from creditors in the event of bankruptcy. Therefore structuring critical business assets such as you commercial property with a SMSF provides additional asset protection.
  • Get into the property sooner - By using your super, you can utilise previously locked away capital to fund your property purchase deposit. This can get your business into a new premises sooner.
  • Concessional Tax Rates - Investment income from your Fund is taxed at the concessional superannuation rates – currently 15% and potentially 0% in retirement. This can result in considerable savings when compared to company (max 30%) and personal marginal tax rates (max 45%).
  • Unused Concessional Cap - If you haven’t been contributing to your super but have been saving, you and your partner could fund your property deposit by utilising any unused concessional contributions, up to $125,000 each by 2022, which potentially is tax deductible.

Disadvantages Of Borrowing Within Your SMSF

1. Limited choice of acquirable assets

The ATO has several onerous regulations regarding the type of assets that can be acquired via a LRBA, who the asset can be acquired from, and who may use or benefit from the asset. The main component is that the Bare / Holding Trust can only acquire a single asset. This generally means on one title however there are exceptions. One common pitfall is inclusions on the contract – any chattel, removable assets etc. These are an asset themselves and therefore would need their own borrowing arrangement.

Common acquirable assets:

  • Commercial Property acquired from yourself at market rates tenanted by your business at market rates.
  • Commercial Property acquired from unrelated parties and tenanted by your business at market rates or unrelated tenants.
  • Residential property acquired from unrelated party tenanted by an unrelated party.

Note: Residential property and related parties do not mix.

DO NOT PURCHASE a residential property from yourself or family. Don’t rent the property to yourself or family – even at market rates. This includes a holiday home. Don’t risk it, It is not worth it!

2. Alterations and Improvements

Assets acquired under a LRBA cannot be replaced with a different asset – in that the nature of the asset cannot be fundamentally changed. However, alternations or improvements that increase the functional efficiency of the asset, but do not change the nature, are permitted, provided it is not financed with borrowed monies.

3. Common disallowed alterations & improvements:

  • Changing property from residential to commercial.
  • Subdividing property into multiple lots.
  • Renovating kitchen with borrowed monies.

4. Liquidity

Careful planning is required to ensure that the SMSF has sufficient liquidity to meet the costs of the property; loan repayments & general property expenses, when they fall due. Consideration needs to be given to retirement timing, contribution caps, cash reserves, and insurances to cover against – vacancy, job loss, injury, and death of a member.

5. Documentation

The structuring and documentation requirements of the ATO and various State Office of Revenues are substantial. These arrangements are not easily restructured and can result in the entire arrangement being required to unwind resulting in significant loss.

It is vital to engage accountants, lawyers, lenders, finance brokers, and real estate agents that have experience across these arrangements to ensure compliance.

SMSF: LRBA Establishment General Guide

Step #1: Establish a SMSF or confirm already established SMSF Fund allows for a LRBA facility

Determine whether a SMSF is right for you.

  • The ATO has great resources for the DIY person, or
  • Alternatively book an appointment with a licensed financial adviser who can legally advise and DIFY (Do It For You).

New SMSF

  • Establish a new SMSF with a corporate trustee (7-10 business days).
  • Complete rollovers of existing super, if applicable (up to 28 business days).

Existing SMSF

  • Review the SMSFund’s Deed (Governing Rules) to ensure it allows borrowing.
  • Consider whether the asset and the associated borrowing is consistent with long-term retirement investment strategy.

Step 2. Meet with your accountant / specialist adviser.

Given the complexities involved and the significant consequence for mistakes, it is vital to involve your accountant and specialist financial advisers early. This can help avoid any costly problems such as double stamp duty, losses due to forced sales and ATO penalties.

Step 3. Speak with RedCap Finance Brokers for an Initial SMSF Loan Consultation

Borrowing money via your Fund can involve significant red tape and lender requirements. It is worthwhile establishing what your lender will require early, to manage expectations and avoid delays.

Step 4. Find the Right Property to satisfy your SMSF's investment strategy's requirements.

Once your SMSF, accountant, and lender are ready, it is now time to find your SMSFund’s new property. Our Real estate partner's (U1st Realty) can assist you with finding a suitable investment property to satisfy your SMSF's investment strategy's requirements.

NB: In Step 2 – you will have discussed in detail the regulations in regard to the types of property and any restrictions. In Step 3 – you will have spoken with a lender about how much you could borrow as well as the SMSF’s ability to service the loan, so you know how much you can afford to invest.

Step 5. Engage an experience conveyancing lawyer.

Having a lawyer that specialises in LRBAs can help streamline the entire process and ensure no documentation or timing issues occur. They will also advise the stamping requirements in your state.

Step 6. Finalise your Loan Application and set up the required structure.

Before you sign any contract, you need to have finance in place and the structure that will hold your new asset needs to be set up. This may include:

■ Finalising Loan Application.

■ Establishing a Bare Trust.

■ Establishing a company to act as the corporate trustee to the Bare Trust.

■ Establishing a company to act as the corporate trustee to the SMSF.

The execution (signing) of the structure in relation to the execution of the contract is determined on which state your property is located. Your conveyancing lawyer in the next step will help with this.

Step 7. Sign the contract in the correct name and pay deposit.

The exact entity name required on the contract varies from state to state. Consult your lawyer. Getting it wrong can mean double stamp duty or rescission of contract and loss of deposit. Sign the contract in line with the terms and conditions required by you lender – subject to finance, number of days settlement etc.

Please Take Note: Ensure that the deposit is paid directly from the SMSF. To not do so may have severe financial and legal consequences upon your SMSF.

Step 8. Settle the property and sign mortgage.

Settle the property from the SMSF and the loan amount. Your lawyer with knowledge of Super and LRBAs is going to be able to smoothly guide you through this process. Once the loan is approved, sign off all mortgage documentation with your lender – double check everything.

Step 9. Manage the asset and loan.

The asset is now beneficially held for the SMSF. This means the SMSF is now responsible for managing the asset, collecting market rent on time, paying bills, repairs and maintenance etc. The SMSF is now also responsible for servicing the mortgage.

CONGRATULATIONS - You Now Have A Quick Overview On How To Invest In Property Through Your SMSF!

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