Limited recourse borrowing arrangements by SMSFs

Keeping You In The Know – Experts Advice

With many trustees of Self Managed Superannuation Funds (SMSF) taking the opportunity to purchase investment properties in their SMSF, the requirement to enter into limited recourse borrowing arrangements (LRBAs) has caused some uncertainty with respect to compliance and taxation issues.

SMSFs are generally prohibited from borrowing, but since 2007 there has been an exception where an SMSF borrows on a limited recourse basis* to acquire a specific asset, however very strict conditions need to be met.

One of these conditions is that the asset is not held in the name of the SMSF, but is instead held under a separate trust (e.g. a holding trust).

A trustee of an SMSF who enters into a LRBA for the purpose of purchasing an asset will be treated as the owner of the asset for income tax purposes, meaning the SMSF will be assessed on the income earned on the underlying asset (such as rental income) and will be able to claim any relevant deductions.

Where the LRBA is set up appropriately, there will be no need for the holding trust to lodge an annual return with the ATO.

SMSFs entering into LRBAs need to do so carefully, because any resulting arrangement that does not meet all the requirements would contravene the borrowing prohibition and place the compliance status of the super fund at risk. For example, if the SMSF purchased a rental property, that property cannot be used by the trustees or related parties. This is a breach of the “in-house asset rule” and could result in the property having to be sold. Many trustees are misinformed by “friends” who are “getting away with it” in regards to personally using the SMSF assets. Don’t jeopardise your whole retirement – do your own research and get good advice.

With all matters regarding SMSFs it is important that trustees understand their legal responsibilities in managing the SMSFs.

Another consideration for SMSFs with residential investment property is the Capital Gains tax advantages at retirement, but that is for another “Expert Advice” column, another day.

* Limited Recourse basis – the rights of the lender against the Super Fund for default are limited to the security.

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