Types Of Assets You Can Purchase
There are certain types of assets that you can purchase with your SMSF using borrowed funds and these include:
- Property such as residential property, commercial property, industrial property and in some situations, even farms.
- Managed funds
To enable your SMSF to borrow funds to acquire one of these assets, you will need to enter into a limited recourse borrowing arrangement (LRBA) as set out by the Australian Taxation Office.
An LRBA allows your super fund to purchase an asset and if you happen to default on the loan, the lender can only sell that particular asset to recover the outstanding debt. This protects the rest of the assets (including cash) in your SMSF.
Remember though, that you can only purchase a single asset with an LRBA, such as a single property or one parcel of identical shares. Also note that the asset which was purchased using the LRBA cannot be replaced while the agreement remains in place, so in the case of shareholdings, they cannot be traded.
What Are The Rules Of An LRBA?
There are certain rules governing how you can use the funds that your super fund has borrowed within the terms of an LRBA. In simple terms, these are:
- You can only use the borrowed funds to purchase a single asset, such as a residential or commercial property, or a collection of identical assets such as identical shares with the same market value.
- You cannot use the borrowed funds to improve an asset which has already been purchased by your SMSF however, you can use them to repair or maintain the asset (which is usually a property).
- The asset must be held in a separate security trust until all loan repayments have been completed. The repayments are made by your SMSF but the SMSF trustees can receive any investment returns which are earned by the asset during the limited recourse borrowing agreement.
- Once the loan has been repaid, you can then move the property from the holding trust into your SMSF which in turn, acquires legal ownership of the asset.
- You can make repairs and maintain the property during the loan period however, you cannot improve or replace the asset in any way during the term of the agreement.
What Are The Limitations Of Using Borrowed Funds Within An LRBA?
There are certain things that you can and can’t do to a property with the borrowed funds under the LRBA rules. Specifically, you are able to use the funds to maintain and repair the property but you cannot use the funds to improve the property in any way.
Let’s look at the individual definitions and what they relate to:
- Maintaining The Property – This relates to ongoing maintenance of the property to prevent defects, damage or deterioration.
- Repairing The Property – This relates to fixing any defects, damage or deterioration or restoring the function of a property. For example, its former appearance, form, state or condition.
- Improving The Property – This relates to significantly altering the state or the function of the property.
So that you can better understand what is meant by these conditions, let’s look at some example of what you can and cannot do.
It is possible however, to make some improvements to the property as long as they are funded by your SMSF and do not change the character of the property. These include adding an extension, installing a swimming pool, garage, garden shed or driveway.
Because these improvements still retain the original character of the property, they will not void the existing LRBA used to purchase the property in the first place.
What You Should Consider Before Borrowing Funds Through Your SMSF
The most important thing to consider when you’re considering borrowing funds to purchase an asset through your SMSF is whether the expected return from the asset will exceed the borrowing costs in the short term. These costs include the annual interest, management and establishment fees.
You also need to ensure that your SMSF has the capacity and regular income to be able to furnish the loan over its entire term.
Most importantly, making these type of financial decisions with your super fund requires careful research and the advice of a financial expert. If your accountant is well versed in SMSFs and knows everything about LRBAs, then he or she would be a great person to consult regarding the acquisition of an asset using borrowed funds.
Talking to a mortgage broker who is familiar with self managed super funds and how to structure a property purchase through your fund would also be very beneficial.