Unlike managed super funds, SMSF trustees or fund members may take out a loan to invest in property through their SMSF using a limited recourse borrowing arrangement (LRBA).

However, purchasing any asset using an LRBA may only be done under certain conditions to avoid breaching super laws and should be in line with the trust’s objectives.

What’s an LRBA?

An LRBA is the only type of loan allowed for SMSFs because it limits the lender’s recourse (i.e. what assets the lender can take) if the borrower defaults on the loan.

Since they can’t come after other SMSF assets in the event of a default, lenders are usually stricter when it comes to approving LRBA loans.

What do you need to buy a property through your SMSF?

Some people set up an SMSF with the idea that they can buy a property through it right away, but there’s a criteria that an SMSF and its trustees must satisfy to qualify for the entitlement.

An SMSF loan is only allowed if the acquisition passes the sole purpose test, adheres to super laws, and is explicitly allowed in the SMSF trust deed. If allowed, the SMSF will use an LRBA to ensure that the lender’s claim is limited to the asset that was bought with the borrowed money. This means that failure to pay for the loan wouldn’t jeopardize other SMSF investments and assets.

Enough super balance
There’s no required minimum balance for SMSFs, but lenders typically approve only up to a maximum of 80 per cent loan to valuation ratio (LVR). This means the SMSF should already have at least 20 per cent of the property’s price prepared as deposit.

Another reason for this is because all repayments towards the loan must be made from the SMSF, regardless if it is sourced from rental income from the property or the beneficial owner’s contributions to the fund.

It’s also worth noting that some institutional lenders don’t consider LRBA loan applications from SMSFs whose balances are lower than $200,000.

A new trust
To enable an LRBA, the SMSF must create a new trust for the sole purpose of holding the acquired asset – in this case, a real estate property. The property will then be held on separate trust until the loan is repaid, but beneficial ownership of the property belongs to the trustee or member who initiated the LRBA.

As beneficial owner, the trustee is responsible for meeting loan repayments and, in turn, are entitled to the property’s earnings and capital gain when sold.

What types of property may be purchased?

SMSFs may purchase a residential or commercial property using an LRBA if it is in line with its investment strategy.

Residential property
SMSFs may invest in a residential rental property. The beneficial owner or the trust may manage the property, but the rental income must be paid towards the trust. 

Commercial property
SMSFs may manage a business as part of its investment strategy as long as it is allowed in the trust deed and is aligned with the trust’s risk profile. In this regard, a trust may also purchase a commercial property to serve as its business premises using an LRBA – provided that the property is a single acquirable asset.

However, SMSFs cannot give anyone special treatment when it comes to transaction related to any SMSF asset. Any business conducted from the asset must be at a commercial arm’s length basis. If the trustee who initiated the purchase is a business owner who wants to use the property for their business, they must pay for rent at the full market rate on top of making loan repayments for expenses related to the purchase.

In addition, the trustee may acquire the asset from the trust after one or more payments are made.

LRBA limitations

There are certain conditions that limit a trust’s opportunity to use LRBA even if the property purchase is allowed in the trust deed. An LRBA will only be approved if:

It passes the sole purpose test
An SMSF should be established for the sole purpose of securing and providing retirement benefits to its members – or their dependants if a member dies.

This means an LRBA is only possible if the trust or trustees will benefit from its gains (i.e. income or capital gain) in retirement and not before it. Even related parties may not receive any benefit – not even a discount – from an SMSF property.

Complies with superannuation laws
Before buying any asset through your SMSF, trustees need to ensure that potential purchase will not breach the Superannuation Industry (Supervision) Act 1993 and the Superannuation Industry (Supervision) Regulations 1994.

Has no related party transactions
Super laws prohibit SMSFs from transacting with related parties whether for the purchase, life or disposal of the asset to ensure commercial competitiveness.

This means:

• Trustees may not buy a property from their co-trustees or any related party.
• Trustees, fund members and their related parties may not reside in the property.
• Trustees may not rent out the property to fellow trustees, members or any related party.
• The property may not be sold to fellow trustees, members or any related party.

Seek professional advice

Just because an SMSF qualifies for an LRBA doesn’t mean that the trust should take out a loan. There are many factors to consider, such as the trust and individual trustee’s financial situation.

It’s best to seek the advice of a licensed financial adviser who can take the trust’s circumstances and objectives into consideration before deciding whether to buy a property with your SMSF.

Explore Nest Egg for more SMSF guides.