Limited Recourse Borrowing through your SMSF
Changes to superannuation law allow for a self managed superannuation fund (SMSF) to borrow to acquire assets as part of their fund’s investment strategy.
If you are a business owner or property investor, you can use these arrangements to buy residential and/or commercial property through your SMSF.
How does SMSF Borrowing work?
SMSF borrowing works by your SMSF borrowing funds to acquire an asset, such as real estate (whether residential or commercial). The SMSF holds a beneficial interest in the investment until such a time as the loan is repaid. The Trustee of the Holding or Bare Trust holds legal ownership of the acquired asset on behalf of the Fund (see diagram below).
SMSF Property Investment
For an SMSF property investment, the SMSF takes out the loan and contributes cash to pay the deposit, meet the legal costs and stamp duty. The SMSF then manages the property in the same way as you would any other real estate investment.
It is important to note that the borrowing is a limited recourse loan. This means that the acquired asset is the only asset that can be used as security. In the event of loan default, the lender and any other person’s rights are limited to that asset. No claim can be made on any other assets of the self managed super fund.
Assets such as property can be leased from the SMSF on commercial terms. Rental payments, superannuation contributions (e.g. SGC and salary sacrifice) and other income enables the SMSF to meet loan repayments and expenses associated with the property. All income and expenses are received and paid by the fund (not the Custodial Trustee holding the asset). For a commercial property, the tenant can be a related party such as your family business; or an unrelated party under lease. For a residential property the tenant must be an unrelated party.
When the loan is repaid, legal ownership of the property is transferred from the Bare Trust to your SMSF.
Who is the lender to the SMSF?
Superannuation law allows for the lender to be any one who can ordinarily lend money. Many financial institutions now have SMSF loan products available. You can also lend money to your SMSF on an arms-length basis.
Important considerations for SMSF property investments
The following issues need to be considered when borrowing to acquire property within an SMSF:
- The law allows only for a ‘single acquirable asset’ or collection of identical assets only. Certain properties such as an apartment may have a car park on separate title which may require more than one bare trust arrangement.
- As the rights of the lender are limited to the property, financial institutions will typically request for a personal guarantee by the member (to protect again default on the loan).
- You do have the ability to refinance loan arrangements and can included associated expenses within the borrowing (i.e. stamp duty, loan costs, brokerage, etc.)
- You are unable to develop or subdivide a property held within a custodian trust that was acquired using a limited recourse borrowing.
SMSF Strategies & Opportunites
There is a wide range of strategies available to use borrowing inside a self managed super fund. Consider some of the following arrangements where this strategy might be beneficial:
- Your business no longer wants to rent or wishes to upgrade their existing premises.
- Commercial property held outside of super (you can transfer the property into a SMSF).
- Residential or commercial property investors.
- People looking to buy a property to that they will retire at in the years to come.
- Property development & using a SMSF (see blog article for further details)
SMSF Borrowing Benefits
Borrowing within a SMSF allows members to accelerate their wealth accumulation through making loan repayments with pre-tax contributions. Investment income is concessionally taxed and there is no CGT if the asset in sold in retirement.
Need more information on SMSF Borrowing?
Further information on self managed super fund borrowing and other trustee education articles, booklets, webinars amd videos are available free for members of SMSF Academy members - read more about SMSF Academy Trustee Membership benefits here.
