SMSF borrowing to buy property (Part 1)

Overview

Limited recourse borrowing arrangements (LRBAs) enable self-managed superannuation funds (SMSFs) to borrow to purchase assets, with real property being the most common.  This article follows on from the first article on SMSFs and buying property.  Being one of Australia’s largest SMSF administrators, we get asked many questions about borrowing through an SMSF to buy property, and it is important the rules are followed to ensure compliance.  In many instances, it can be very difficult to rectify mistakes after the fact.

What are LRBAs?

Basically, an LRBA is a loan to an SMSF to purchase an asset which the fund is ordinarily permitted to purchase under the superannuation rules.

The legal title to the investment must be held by a third party on trust for the SMSF trustees. The SMSF trustees have a beneficial interest in the asset, and the right to acquire the legal ownership of the asset by paying-off the loan.

The borrowing is limited recourse, meaning that the recourse of the lender or any other person against the SMSF trustee is limited, in the event of default, to the specific asset only; and any related fees are limited to the rights over the asset or its replacement.  The lender is not allowed to recover money from other assets of the SMSF.

How is a borrowing arrangement structured?

The key elements of a LRBA are as follows:

SMSF trustees

  • Select the asset to be acquired;
  • Organise the loan;
  • Establish the custodian trust;
  • Pay the deposit;
  • Receive income from and pay expenses associated with the asset; and
  • Make instalment payments on the loan.

The custodian

  • Purchases the asset under a custodian trust; and
  • Holds the asset as the legal owner until the loan is repaid or the asset is sold.

The lender

  • Can be a related party or a commercial lender.

The following diagram outlines the typical structure of an SMSF LRBA arrangement:

Establishing a custodian trust

The custodian trust is established via documentation (a Custodian Trust Deed).  This document outlines the rules of the trust to make sure it complies with the super borrowing requirements, the property particulars, the beneficiaries and other relevant matters.

The custodian trustee can be either a company or one or more individuals.  The custodian trustee cannot be the same individuals or company as the SMSF trustee.  However, if the SMSF has:

  • A corporate trustee – then one or more of the directors of the SMSF corporate trustee can be directors of the custodian corporate trustee, but this company cannot be the same as the SMSF trustee.
  • Individual trustees – then some, but not all, of the individual trustees can be the custodian trustee.

The trustee of the custodian trust can be any person or company known to the SMSF trustee(s).  Most commercial lenders require the custodian to be a company, to prevent title registration issues if an individual dies.

Types of assets permitted in a borrowing arrangement

An SMSF can invest in a wide range of assets through a borrowing arrangement:

  • A collection of shares in a listed company;
  • A collection of shares in a private company;
  • A collection of units in a unit trust (such as a managed fund);
  • Commercial property;
  • Residential property; snd
  • Any other asset an SMSF can normally invest in, such as bullion.

Each loan must be for the acquisition of a single asset.

For assets such as shares and managed funds, each loan must be for shares in a single company with the same rights, or units in a managed fund with the same fixed rights.

In relation to property, a single asset is usually considered a single title for land and the accompanying house.  However, a property consisting of two or more titles can be treated as a single asset if the titles are linked either physically or legally.  For example, a legal impediment to treating a farm consisting of three titles as separate assets, or a factory sitting across two titles. (Confusing: are they saying there IS a legal impediment in this case, or there IS NOT?)

Acquisition of assets from a related party

The same rules apply to acquiring an asset from a related party using a borrowing arrangement as do normally – that is, buying assets from a related party is generally prohibited unless they come under one of the exceptions:

  • Business real property;
  • Listed securities;
  • Widely held trusts, such as managed funds; and
  • Units in a related unit trust (subject to certain restrictions).

Can I lease a property subject to an SMSF loan from my SMSF?

A related party generally cannot lease residential property from an SMSF. However, a related party can lease a commercial property from an SMSF, subject to certain conditions being met.

Can I repair a property subject to an SMSF loan with borrowed funds?

Properties can be repaired with borrowed funds, and restoring something to its original form and function will not contravene the borrowing rules.  But rundown buildings that are substantially renovated could be considered an improvement of property.

Can I improve a property subject to an SMSF loan with borrowed funds?

No.  But a property subject to an SMSF loan can be improved with the fund’s own cash resources, so long as the improvements do not create a new physical or legal asset.

Can I develop a property subject to an SMSF loan?

No.  An SMSF cannot borrow to buy a vacant block of land and develop it.  This will change the nature of the original acquirable asset; that being the vacant block of land.

Who can lend to my SMSF?

The lender can either be a commercial lender such as a bank, or a related party lender, such as a member of the fund or a relative of that member.  However, related party members must lend to their SMSF on either commercial terms or satisfy the ‘Safe Harbour’ provisions (more on this in Part 2).  Failure for related party lenders to satisfy these provisions may lead to penalty rates of tax on rental income and capital gains on the sale of the property.

What happens when I repay the loan?

Upon the fund’s repayment of the loan, the legal title of the property is ordinarily transferred from the Custodian Trustee to the SMSF Trustee(s), and if structured correctly, there should be no tax or stamp duty consequences.

Steps for success in a SMSF borrowing arrangement:

1. Determine (often with the help of the fund’s accountant or financial planner) that borrowing would be an appropriate strategy in an SMSF, including discussions around insurance and exit strategies;

2. Check the trust deed to ensure the SMSF trustee has the power to borrow, grant security and allow an asset to be held by the Custodian Trustee(s)/nominees for the trustee (if not, amend the trust deed);

3. Check the fund’s investment strategy to ensure it allows for the acquisition of the investment asset and permits borrowing for that purpose (if not, amend the investment strategy).  Ensure the asset meets the definition of a single acquirable asset;

4. Source the asset for purchase, negotiate the price and reach agreement with the vendor;

5. Finalise borrowing arrangements with the lender, including in-principle loan approval;

6. The custodian trust should be a bare trust. Determine who is to be the custodian trust trustee (if a new company, establish this entity);

7. Arrange for the custodian trust trustee to resolve in writing to act as custodian trustee of the asset for the SMSF trustee;

8. Arrange for the SMSF trustee to resolve in writing to purchase the asset and to appoint the custodian trustee to act for the SMSF trustee as custodian trustee of the custodian trust;

9. Arrange for the custodian trustee (NOTE: not the SMSF trustee) to sign the purchase contract;

10. Ensure the SMSF trustee provides all the deposit money for the purchase directly from the SMSF’s bank account;

11. Arrange for the custodian trustee and the SMSF trustee to sign the trust deed of the custodian trust;

12. Arrange for the SMSF trustee (which is the borrower) to sign all loan documents with the lender;

13. Complete the purchase of the asset using only the SMSF’s money and the loan by the lender;

14. Submit the custodian trust deed to the stamp duty authority for payment of stamp duty (check the state laws as there are stamp duty variations between jurisdictions); and

15. When the loan is eventually repaid, transfer the asset from the custodian trustee to the SMSF trustee. There will be only nominal stamp duty payable provided the custodian trust deed was stamped previously (if required in the state) and the custodian trust is a bare trust.

What does Neo Super provide?

We provide a fully integrated, flexible and comprehensive SMSF borrowing arrangement documentation service for property, which includes:

  • Custodian trust deed;
  • Limited recourse borrowing trust agreement;
  • Statutory declarations;
  • Member acknowledgements;
  • Certificate of beneficial ownership; and
  • Trustee resolutions.

For borrowing arrangement documentation for assets other than property, please contact our office.

Stay tuned for SMSF borrowing to buy property (Part 2), in which we examine the rules for related party loans.

Further Information

If you have any questions about this Fact Sheet please contact Nicholas Ali, SMSF Head of Technical Services via email nicholasa@neo-super.com.au or mobile 0400 050 236.

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NEO Super is an independently owned specialist self-managed super fund (SMSF) Administrator, with more than 25 years SMSF specific industry experience.

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