Do's & Don'ts with Property in an SMSF Under a Limited Recourse Borrowing Arrangement

For many, what draws them to self managed superannuation is the attraction of being able to utilise their super balance and borrow money to purchase a property. After all, an SMSF is the only retirement vehicle that allows its members to hold real property within their fund.

However, it often comes as a surprise that the ability to do this is in fact an exception to the rule. That rule being that super funds cannot borrow. It has only been since late 2007 that it became possible for an SMSF to borrow to purchase an asset. And the only way to validly do this, is via a limited recourse borrowing arrangement (LRBA).

Limited recourse borrowing arrangement (LRBA)

LRBA's come with a number of requirements that not only need to be met when they are initially established, but for the life of the borrowings. Many are not aware of these and assume borrowing in their SMSF is the same as if they did so in their personal name. Failure to adhere to these additional requirements can result in the breach of the LRBA which can have significant consequences for the trustees and the SMSF.

This article looks as some of the criteria that are required to maintain a successful LRBA and how they relate to activities involving property investment.  

The particulars of the arrangement that will be examined include the following:

• Concept of 'repairs and maintenance' vs 'improvements' of a property and how these can be financed when a property is under an LRBA.
• The asset for which the LRBA is established must not be replaced. If replaced, the LRBA no longer exists.   The tax office has cited a number of situations where a property will be considered to have been 'replaced'.
• A LRBA can only be used to purchase a 'single acquirable asset'. This will be explored in relation to real property.

Repairs and Maintenance can be financed by borrowings

Improvements to a property must be financed by existing SMSF monies (not borrowings)

'Repairs & Maintenance' Defined

• 'work done to prevent defects, damage or deterioration of an asset, or in anticipation of such things.
• The work must merely ensure the continued functioning of the asset in its present state.
•  A repair merely replaces a part of something or corrects something that is already there, that is now worn out as a result of normal wear and tear, or is damaged accidentally or deliberately, or by natural causes.
• A repair is 'occasional & partial'.

'Improvements' Defined

• A property is 'improved' if its state or function is significantly altered for the better, through substantial alterations, or the addition of further substantial features to the property.
• There are 'alterations' that may be done to the property that don't amount to an 'improvement'. Alterations do not constitute an improvement if the asset is 'only bettered to a minor or trifling extent as compared to the asset as a whole'

Here are some practical examples to help understand these definitions:

Further examples of Repairs & Maintenance (can be paid for by borrowings):

• Gutter replacement, including with a modern equivalent and a leaf guard.
• Repainting of house
• Fence replace with modern equivalent materials, can include adding a gate to provide another access point.
• Installing a fire alarm to meet with local council requirements

Further examples of Improvements (must be paid for by available money in the SMSF):

• Swimming pool installation
• Building a pergola
• Adding a second bathroom
• Installing a home automation system.
• Farming property – add additional bores, yards, sheds or fencing.

'Original Asset' vs 'Replacement Asset

Whilst a property is subject to an LRBA, it must not be dealt with in such manner that constitutes the 'replacement' of the original asset for which the arrangement was entered. Here are some examples to further explain this concept. Once the original asset is 'replaced' the LRBA ceases. If borrowings still exist and the LRBA ceases, a breach has occurred.

Following are examples of where changes have been made to a property, but aren't considered fundamental enough to in fact replace the original asset. The original LRBA is maintained. However, the funding for these changes must come from already available monies in the SMSF and not from borrowings.

'Single Asset' in the context of property

For the purposes of LRBA's, one title equals one asset. However sometimes what appears to be on just one asset actually exists over multiple titles. The tax office has clarified common scenarios to ensure you set up multiple LRBA's if applicable.

If you have any questions in relation to the information provided, please do not hesitate to contact a qualified and experienced SMSF Specialist accountant in our team.

Telephone: 1300 6110 320

Email:  smsf@hrblock.com.au

Important information

This content has been prepared by H&R Block Ltd ("H&R Block"), ABN 89 064 268 800. 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, H&R Block, its officers, employees and agents 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.