Loan Structure Options for SMSF Borrowing

SMSF Loan | SMSF Borrowing | Limited Recourse Borrowing | SMSF Loans | SMSF rules on borrowings

An SMSF can borrow money for a short period of time if that amount is less than 10 per cent of the fund’s total assets. Those conditions are:

* A maximum of 90 days to meet benefit payments or to pay an outstanding surcharge liability; or

* A maximum of seven days to cover the settlement of security transactions. You can also only do this if, when you bought the securities, you did not think you would need to borrow funds.

However, there are exceptional circumstance when an SMSF can attain loans, they are:

1. Limited Recourse SMSF Borrowing Agreement

2. Related party

Changes to superannuation legislation now allows an SMSF to borrow funds for property investment. If you have an SMSF, you might now be able to borrow money to buy a commercial or residential property through your SMSF.

Limited Recourse Borrowing Arrangement

If the SMSF has enough funds for a deposit, the remainder of the purchase price can be borrowed. The SMSF can either borrow from a financial institution e.g. a bank, a credit union or from the Members.

Lending is done with non-recourse borrowing arrangements. This means the lender does not have a recourse or right on other assets in the SMSF. For this reason, the lender (bank) will ask the Members for a guarantee. This arrangement is generally referred to as a limited recourse borrowing arrangement.

The lender provides the Fund for a partial payment of the property and also pays all the relevant fees. The SMSF will borrow to settle the balance.

Where a bigger deposit is paid by the SMSF on the investment property, the bank may not ask for security from the Trustees. The property will be the sole security for the loan under this limited recourse loan agreement. In the event of default, the lender only has a recourse on the property. The lender can never claim against other assets within the SMSF.

As a general rule-of-thumb, a bank will lend 80% on residential property and ask for a guarantee from the trustees, or won’t ask for a guarantee at 60% loan rates. The benchmarks on commercial property are 70% and 50%, respectively. Factors the bank assesses to decide if there is a need of a guarantee are property quality, credit history and rental income.

Technical Analysis

An LRBA arrangement may be perceived to be an in-house asset as it holds 100% interest in another related entity. However, a ruling was issued by the ATO confirming that it is not an in-house.

Ownership

The investment property is owned by the bare trust with the SMSF having a beneficial entitlement to it. The bare trust is merely the holder of the title until the loan is paid off. The SMSF will receive lease payments from the lessee and will expense the interest paid on the SMSF loan.

After the loan is repaid, the SMSF has the right, but not the obligation, to acquire the legal ownership of the investment property.

Does an LRBA asset have to be transferred to the SMSF when the loan is repaid?
  • Property can either remain under the Bare Trust or the ownership of the property can be transferred from a Bare Trust to the SMSF.
  • Be mindful, if the property’s title is transferred from the Bare Trust to the SMSF, the Bare Trust cannot be “reused”. A new Bare Trust will need to be set up if the SMSF wants to purchase a new property via an LRBA.
  • If the property remains under the Bare Trust, the nature of the property cannot be fundamentally altered.

Related Parties

When purchasing a residential property, the SMSF cannot have any dealings with a related party. This means you can not sell your house to the SMSF. The Fund also cannot rent the property to a Trustee or a family member such as mother-in-law. You can, however, purchase the property from the SMSF when entering the pension phase.

When lending to an SMSF, Trustees need to ensure that terms of lending are on an arm’s length basis and issued on commercial terms. The Tax Office has recently published a practical compliance guidance (PCG 2016/5) which sets out the recommended interest rate and loan terms for a related party loan to the SMSF. This is known as the Safe Harbour Provision.

Safe Harbour Provision

For SMSF Trustees with Limited Recourse Borrowing Arrangements (LRBA’s), the Commissioner may not accept the arrangement to be at arm’s length as there is no certainty provided. For more information, see the link below:

Safe Harbour Provisions

Please note a sample loan repayment schedule here.

Benefits of Purchasing Property in Your SMSF
  • commercial property owned by you can be sold to the SMSF at market rates;
  • assets in the SMSF are secure as the lender only has a recourse on the investment property, plus any additional security provided by the guarantor;
  • the loan is paid off by using super contributions and rental income;
  • the SMSF is only taxed at the net income after loan interest and expenses are deducted against the rental income;
  • the SMSF is only taxed at a rate of 15% compared to marginal rates if the property was purchased in a personal capacity; and
  • capital gains will only be taxed at a rate of between 0% – 15%.
Things to Consider
  • the SMSF needs to be established before the Bare Trust and Custodian Corporate Trustee are established;
  • the Bare Trust and Custodian Corporate Trustee are mere title holders of the property and all transactions will occur within the SMSF;
  • the Trust Deed provided by Superannuation Warehouse will allow for borrowings;
  • the investment strategy of the SMSF should allow for property investment;
  • the SMSF will require sufficient cash flows to service the loan. This can come from rental incomes, investment earnings and member contributions;
  • all transactions incurred must be at arm’s length and at market rates; and
  • do not consider buying a holiday property in your SMSF and then using it.

All investments purchases should serve the Sole Purpose Test.

Bank and Broker Information

You are free to use any banks or lenders when financing for your SMSF property purchase. To get the best deal possible, you’d be well advised to use a mortgage broker. You can use a big bank or one of the niche players like Macquarie who has a very informative free brochure with some great examples. You can also download a cash flow analysis brochure here which gives examples on the cash flow details of an property with a limited recourse borrowing arrangement in place.

Trustees can contact Robert Sestan from Park Road Finance, Matt Atkinson from Condor Finance Partners or John Gregory from Money Quest Finance Specialist for more information. Their contact details are noted below:

  • Robert Sestan (Park Road Finance)

Benefits of SMSF Lending with Park Road Finance:

    1. One-Stop Shop for your SMSF lending requirements
    2. Document gathering and secure Factfind information
    3. Full assessment of borrowing capacity for SMSF, for either refinance or purchase
    4. Extensive panel of 12 lenders, provides you with choice and ensures you are matched with a lender that best fits your requirements and objectives
    5. Lend to either residential or commercial property
    6. LVR (Loan to Value ratio) up to 90% for residential and 80% for commercial properties
    7. Rates starting from 6.93%
    8. We are associated with SMSF administrator Superannuation Warehouse, who assist with your annual SMSF compliance requirements and Bare Trust setup if required
    9. Most importantly, we will be with you from start to finish,

P: 0410 514 887

E: robert.sestan@parkroadfinance.com.au

  • Matt Atkinson (Condor Finance Partners)

P: 03 9670 0222

E: admin@condorfinance.com.au

W: Home – Condor Finance Partners

  • John Gregory (Money Quest Finance Specialist)

P: 0400 830 138

E: john.gregory@moneyquest.com.au

The ATO guidance on limited recourse borrowing arrangements are set out here. If there are any questions you have in the property purchase process, please contact us!

ATO Guidance on Borrowing

The ATO issued a ruling on borrowing. This is set out in the link below:

ATO Rules on Borrowing
Next Step

To send us the property details to set up us Bare Trust, click here to see the info we need.

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