Many individuals are attracted to self-managed super funds (SMSF) because they offer the opportunity to own investment properties that can generate income during retirement. However, a common oversight is that, unlike other types of investments, SMSFs do not allow borrowing to finance property investments.
However, there are exceptions. On 24 September 2007, the Australian government allowed SMSF trustees to borrow money for investment properties through a Limited Recourse Borrowing Arrangement (LRBA).
In this guide, we’re going to talk about what an LRBA is, how they work, how to obtain one, and the considerations you need to take before taking one.
What is a Limited Recourse Borrowing Arrangement (LRBA)?
A Limited Recourse Borrowing Arrangement (LRBA) is an SMSF provision that allows SMSF trustees to borrow money from a third-party lender to buy an asset.
Traditionally, SMSF trustees aren’t allowed to borrow under the Superannuation Industry (Supervision) Act 1993 (SIS Act). But this changed through “investment warrants” which were introduced in 2007. They were changed to LRBAs in 2010 as part of the Simpler Super legislation.
Think of LRBA as a special type of loan. With other regular methods of financing, the lender has access to a wide range of other assets you own if you fail to repay the loan. However, with LRBAs, the lender only has access to the asset you bought using the loan.
This is why it’s called a “limited recourse” loan since the lender’s recourse is limited to that specific asset.
You can borrow between 75% and 80% of the property’s value if you’re investing in a residential property. For a commercial property, you can borrow up to 70% of its value.
How does a LRBA work?
An SMSF can use an LRBA loan to invest in the following assets:
- A residential property
- A commercial property
- Shares or managed funds
- Any other assets an SMSF would ordinarily invest in
Note that SMSFs have strict rules and guidelines. For example, trustees are only allowed to invest in a “single acquirable asset”. This single asset must only be held in a bare trust, we’ll be touching on this later.
Steps needed to obtain an LRBA
Here are the steps to obtain an LRBA:
- An SMSF must be established
- Then a bare trust is to be established which will take out the LRBA
- Then you’ll need to find a lender to obtain funds from
How an LRBA is structured
Here are the key elements that make up an LRBA structure:
SMSF Trustee
The SMSF trustee identifies the investment to be made using the LRBA loan and organises the funding with the lender. They also ensure that holding trust has been established as per the LRBA guidelines.
Once the LRBA loan has been approved, the SMSF trustee pays for the investment property’s deposit through the SMSF bank account. They ensure the rental income from the property pays the expenses and repayments for the loan.
The Holding Trustee/Bare Trust
To access LRBA financing, you need to create a separate trust entity called a holding trustee. This is also known as the bare trust or a custodian trust. It’s essentially an empty trust set up legally to hold or own the investment property on behalf of the SMSF.
The bare trust also holds the asset as the legal owner until the loan is fully repaid or the asset is sold.
The LRBA loan is released to the holding trustee once approved. Also, the holding trustee can only hold one single acquirable asset. If you wish to invest in another property, you need to open another bare trust.
Keep in mind that the SMSF trustee and the holding trustee are two separate entities.
The Lender
This is the party that provides the limited recourse financing. It can either be a related party lender or a commercial lender. If the lender is a related party, the loan terms must be commercial.
LRBA Rules Involving Property Investment
As previously mentioned, LRBAs are some of the most heavily regulated entities in Australia. All parties involved must meet ATO rules and regulations not only at the initial setup but throughout the life of the borrowing.
LRBA rules to keep in mind include:
- Borrowings can only be used for repairs and maintenance
- The property purchased must not be replaced
- LRBA can only be used to purchase a “single acquirable asset”
- When borrowing from a related party, ensure safe harbour guidelines are followed
Let’s look at each of them below:
Borrowings can only be used for repairs & maintenance
Money borrowed from an LRBA can only be used for repairs and maintenance, not improvements. ATO outlines what it considers repairs and maintenance versus improvements in SMSFR 2012/1.
Repairs involve restoring an asset to its former condition by fixing physical damage or wear and tear, such as replacing part of a bathtub without replacing the entire bathtub.
Maintenance includes work to prevent or anticipate damage, ensuring the asset continues to function in its present state.
In contrast, improvements significantly enhance an asset’s value or functionality, such as adding substantial features or making major alterations.
For example, if an LRBA property’s roof is damaged by a cyclone, replacing the roof with a modern equivalent is considered a repair. However, adding an extra story during the roof repair is classified as an improvement.
Improvements cannot be funded by LRBA borrowings and must be paid for using existing SMSF funds.
The property purchased must not be replaced
Replacing an original asset isn’t allowed. Only certain LRBA assets, such as shares, installment receipts, and units can be replaced in certain conditions, such as during a takeover, restructure, merger, or demerger of the unit trust or company.
Property improvements can’t be made to the extent that the property’s features and characteristics change and the property becomes a ‘different’ asset.
You can make such improvements only after the LRBA loan has been repaid in full and ownership of the property is transferred to the SMSF.
For example, let’s assume the SMSF invested in a housing complex with parking. Let’s say the property is divided into two where the housing complex and the parking become separate properties with two different titles.
In this case, the property’s characteristics change and it’s no longer a single acquirable asset. This isn’t allowed if there are still outstanding LRBA borrowings.
LRBA can only be used to purchase a ‘single acquirable asset’
Under ATO borrowing rules, a fund must acquire a “single acquirable asset,” even if multiple assets are involved, as long as they cannot be dealt with or sold separately by law.
A single acquirable asset typically means a single title for land and its buildings. For properties with multiple titles, like a farmhouse on a farm with different titles, the asset must be considered in both legal and practical terms to determine if it qualifies as a “single acquirable asset.”
For example, a farmhouse and a horse ranch on separate titles that cannot be sold separately is a single asset. If the horse ranch can be sold separately, trustees should consider alternative strategies, such as establishing two separate LRBAs or acquiring one of the titles without borrowing.
When borrowing from a related party, ensure safe harbour guidelines are followed
The ATO has a Practical Compliance Guideline PCG 2016/5, which is also known as “safe harbour guidelines”. This guideline outlines the ATO commercial terms for related party LRBA loan agreements.
If the SMSF trustees enter into and maintain an LRBA with a related party, they must structure the LRBA on an arms-length basis, which means an appropriate rate of market return.
If an LRBA isn’t set up in compliance with the safe harbour guidelines, the SMSF may be compelled to pay non-arm’s-length income tax (NALI) at 45% instead of the concessional rate of 15%. Any realised capital gain might be taxed at 45% as well.
What are the safe harbour guidelines?
The safe harbour guidelines cover the following:
Interest rate
The interest rate may be variable or fixed. The variable rate must be set at the Reserve Bank of Australia Indicator Lending Rates for banks providing variable housing financing for investors. The RBA issues this annual rate before the start of every financial year.
You can find current and past rates on the ATO website. The current SMSF LRBA interest rates for 2024-2025 are 9.35% for real properties.
The trustees may also choose to apply a fixed rate at the beginning of the arrangement for a specific period, up to a maximum of 5 years.
Term of the loan
For an original variable interest rate LRBA loan, the maximum loan term is 15 years for both residential and commercial properties. For a re-financing variable interest rate LRBA loan, the maximum loan term is 15 years less the duration of any previous loan tied to the asset for both residential and commercial properties.
If the trustees opted for a fixed LRBA rate, it may be fixed for a maximum of 5 years and will convert to a variable interest LRBA loan rate at the end of this period. The combined loan term can’t exceed 15 years.
Types of repayment
Each of the repayments, whether it’s LRBA for real property or parcel of shares, is in principal and interest. Repayments are done monthly.
Loan security
Lenders often don’t require a personal guarantee but will need a registered mortgage over the property to act as loan security.
What benefits does an LRBA offer?
SMSF LRBA loans offer trustees the following benefits:
- Increased purchasing power – An LRBA allows you to maximise your retirement savings by increasing the amount available to buy an investment property through your SMSF. This can gear your SMSF towards buying investment properties that are typically out of reach due to a shortage of funds to buy outright.
- Tax advantages & deductions – Getting an LRBA loan for SMSF property investment offers various tax benefits. If you hold the property for more than 12 months, the capital gains tax applied when you sell the property drops from 15% to 10%. You can also enjoy various tax deductions, such as property management and maintenance expenses.
- Asset protection – Buying an SMSF investment property through an LRBA loan adds protection to your assets. If you default on the loan, the lender’s recourse is limited to the single asset purchased using the loan. Super is also a protected asset in case of bankruptcy or business deterioration.
Essential considerations when purchasing property with an LRBA
Ensure you have enough funds in your SMSF
Many investors make the mistake of taking out an LRBA without considering other potential costs that need to be paid. For example, the bank might require you to take out insurance on the property.
Also, consider other expenses associated with borrowing and property acquisition, such as stamp duty, conveyancing fees, brokerage fees, and loan establishment expenses. Don’t forget the monthly repayments plus interest.
All these expenses are paid out from the funds in the SMSF, not the holding trust.
In other words, before entering into an LRBA an SMSF needs to ensure it’s liquid enough to meet its loan repayment liabilities and any other associated costs. If its cash flow position isn’t solid enough, it can impact its LRBA.
Limited lenders available for borrowing & higher interest rates
There are few commercial lenders and banks in the LRBA space. This is because most lenders focus on reducing their risk instead of staying competitive when it comes to limited recourse loans.
As such, most of them impose limitations on loan-to-market value ratio (LVR) and property types you can purchase using an LRBA loan. On top of that, they may have higher interest rates and personal guarantee requirements.
It’s best to take careful consideration and plan well when choosing an LRBA lender. It’s best to seek professional advice from a licensed financial advisor to understand if taking out an LRBA is the right move.
Looking to invest in property with your SMSF? Speak to us today!
At this point, you might be ready to invest in SMSF property through an LRBA loan. However, navigating the complexities of SMSF regulations and LRBA rules can be challenging without professional guidance. Ensuring compliance and making informed decisions is crucial to the success of your investment.
By partnering with Wayfinder, you gain access to expert advice, comprehensive market analysis, and personalized support throughout your investment journey. We work with you to find properties that meet your criteria, negotiate the best deals, and ensure all legal and regulatory requirements are met.
Speak to us today for a free consultation and learn more about how Wayfinder’s expertise as a buyer’s agent can enhance your SMSF property investments. Let us help you make informed decisions and achieve your financial goals with confidence.
