The seven deadly SMSF borrowing sins

The seven deadly SMSF borrowing sins

If you commit one of these seven deadly sins, your limited recourse borrowing arrangement (LRBA) can cost you dearly with double or even triple stamp duty, confusion over ownership and SMSF audit problems.

As Dante journeys through the Inferno, he encounters sinners condemned to eternal damnation because of sins committed on Earth. Now, clearly we don’t equate breaking the SMSF LRBA rules on a par with eternal damnation, but there are lessons from the seven deadly sins that we can apply to LRBA in your SMSF.

Despite recent uncertainty, the government’s decision in the 2015 Federal Budget to leave superannuation alone for the foreseeable future means debt-funded property investing remains a viable strategy for SMSF investors.

 

However, you may have been tempted by the self-proclaimed property guru offering to reveal the hidden secrets to owning fail-safe property in your SMSF. You may have seen the glossy ads from the one-stop SMSF shops offering you an all-encompassing solution.

If you’ve been tempted, heed the seven deadly SMSF LRBA sins.

  • Sloth

Don’t cut corners by trying to do it all yourself or by employing someone who is not a recognised expert. Such false economy may feel cheaper at the time but when it comes to fixing the inevitable mistakes, you will be significantly out of pocket.

Do your research and homework. Check to see if such a leverage property investment is allowed by both your investment strategy and your trust deed.

Also, obtain professional SMSF and property advice well before you commit to acquiring a leveraged property in your SMSF.

Don’t cut corners by buying a property for yourself or from a related party unless it’s business real property. Don’t use the property yourself or let an associate use the property unless it’s business real property.

Avoid the lure of one-stop shops that offer financial planning, real estate, tax and accounting services for your LRBA. Always obtain a second professional opinion.

  • Gluttony

Unless you have the requisite skills, time and knowledge; don’t be a glutton for punishment by taking the entire complex project on your own shoulders. Instead, work with a recognised SMSF expert who can manage the entire LRBA process for you from woe to go.

LRBAs in your SMSF are incredibly detailed and complex processes and a multitude of small and seemingly inconsequential mistakes can down the track lead to disproportionate additional stamp duty and penalties.

  • Greed

Don’t fall for the high-pressure glossy sales pitch. Spruikers will promise you high returns with minimal risks until the cows come home. Don’t let your greed blind you to their incredibly persuasive sales techniques.

An easy strategy to adopt is to pay for an independent property valuation. The peace of mind this will give you will always be worth the price.

Don’t try to cut corners on your financials. Pay market value for the property; pay markets rates for the interest and ensure you have adequate insurance.

As part of your investment strategy, determine a maximum amount that you are willing to borrow. Don’t overextend yourself even if the bank is willing to lend you more.

Avoid the spruikers who continue to push the lure of the zero interest loan strategies. If you’ve got one already in place, speak to an expert about correcting it. The ATO has quite rightly clamped down on this strategy and the fines can be horrendous.

  • Pride

We can all make mistakes at some time, some are small and some are large. So too within LRBAs in your SMSF. If you do identify an accidental mistake, don’t let your pride stand in the way of fixing it as soon as possible.

As soon as you identify the problem, develop a strategy to remedy it. If it is a serious issue, communicate with the ATO about the problem, your proposed solution and the change to your processes to ensure it won’t ever happen again.

Don’t be afraid of the ATO – believe it or not, if you communicate openly with them they can be quite helpful.

Don’t ever fall into the trap of thinking that you know everything about LRBAs. Keep developing your knowledge over time and make sure you keep up to date with any potential developments in this complex area. A great place to start your LRBA education is by Googling ‘ATO SMSFR 2012/1’.

  • Lust

Once you own your leveraged property in your SMSF, there will be great temptation to help increase the value of the property within the tax advantageous environment. You may watch as owners in your local area add significant value to their property with minimal development outlay. The temptation to follow suit could be great.

However, always be mindful that using borrowed funds to improve (or develop) a property is a no-no. Ensure you have a clear understanding of what is meant by repair, maintenance and improvement before you do any work on the property and seek professional advice.

  • Envy

Don’t try to keep up with what you think others are doing in their SMSF when it comes to the size or number of your leveraged SMSF property investments.

Not many wealthy SMSF investors are buying one or multiple properties off the plan sight, unseen in far flung localities. Not many wealthy SMSF investors are setting up a SMSF with the sole purpose of buying and holding leveraged property.

To put things in perspective, since 2007 just under 15,000 SMSFs have invested in excess of $7.4 billion into an average value property of $606,000 backed by an LRBA.

  • Wrath

Accept that at some stage in the future the rules and regulations around LRBAs in your SMSF will likely change. You can’t change that so there is little reason to get angry, fight it or avoid investing because of unknown potential future changes.

Take comfort from the fact that such significant changes are typically discussed well in advance. Additionally, when they are implemented, they typically involve a grandfathering (or grace) period for those who have already entered such transactions in good faith under existing rules.

Avoid the seven deadly sins

When executed well, an LRBA within your SMSF can be a wonderfully effective investing strategy. However, following the rules exactly and having trusted, expert, professional advice is incredibly important.

Tim Mackay, principal, Quantum Financial Planning

The seven deadly SMSF borrowing sins
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