Thinking about using your SMSF to invest in property? With the right structure, your SMSF can borrow to invest. The key is using what’s called a Limited Recourse Borrowing Arrangement (LRBA). An LRBA can help grow your retirement savings, but it also comes with some important rules and risks.
What is an LRBA?
An LRBA is a special type of loan designed for SMSFs. It allows your fund to borrow money to buy an investment asset such as property. The crucial feature is that the lender’s rights are limited to the asset being purchased. In other words, if the SMSF defaults on the loan, the lender can only claim the property bought with that loan and not other assets in the fund. That’s the “limited recourse” part. However, many lenders will still require a personal guarantee. This means that if your SMSF can’t make the repayments, your own personal assets could be on the line.
How does it work?
In simple terms, the SMSF borrows money and uses it to buy an asset which will be held in a special ‘holding trust’ until the loan is repaid. Once the loan is repaid, the asset can be transferred out of the ‘holding trust’ and into the SMSF. Keep in mind that even though the asset is temporarily held in a ‘holding trust’ the SMSF is still entitled to all the income produced by the asset.
Benefits of using an LRBA
One of the biggest advantages is leverage. Your SMSF can purchase an asset, such as a property, that might otherwise be out of reach. Another benefit is the tax treatment within super. Income earned on SMSF investments is taxed at just 15%, and capital gains are effectively taxed at 10% if the asset is held for more than 12 months. In some cases, such as when the fund is supporting a retirement pension, capital gains tax may not apply at all. On top of this, members can continue to make personal contributions, including deductible contributions, to help repay the loan while building retirement savings at the same time.
Downsides and risks
There are also downsides to consider. Even though the lender’s rights are limited to the purchased property, most banks require a personal guarantee, exposing your personal assets if the SMSF defaults. LRBAs are also more complex and costly to set up than traditional loans, as they must follow strict superannuation rules and usually require professional advice.
If the asset makes up a large share of the SMSF’s portfolio, liquidity could be an issue. This is a problem if the SMSF is paying a pension. Also, there are restrictions on changes to the property meaning you can’t build on vacant land or subdivide while the loan is in place. Finally, gearing cuts both ways – while it can boost returns if the asset value rises, it can also magnify losses if the value falls.
Borrowing through your SMSF to buy property can be a powerful way to build wealth, but it’s not without complexity and risk. Getting the structure right and understanding the rules is essential.
