Self-Managed Superannuation Funds and Property Investment Part 1: Using Borrowed Funds for Real Property Investment
By Ron Cohen
4 December 2018
It has been suggested that acquiring property through a self-managed superannuation fund (SMSF) has become increasingly popular.
There are potentially numerous benefits for purchasing property via a SMSF including asset protection and concessional tax on rental income and future capital gains. These benefits and the suitability of using SMSF as an investment vehicle should be carefully considered. Advice from a qualified professional such as an accountant or financial advisor before investing is strongly encouraged.
In September 2007, the superannuation rules were relaxed to allow the use of borrowed funds for real property investment acquisitions. These amendments expanded the reach of these benefits so they could also be enjoyed by SMSFs lacking the money to purchase investment properties outright by having the ability to borrow money to finance a property purchase.
What do you need to use borrowed funds?
In order for a SMSF to borrow funds for property investment, two separate trust deeds need to be established:
- The traditional superannuation trust deed establishing the SMSF trustee as the borrower and the responsible person liable to pay all principle, interest, rates and outgoings applicable to the loan. The deed must have specific power to authorise the SMSF trustee to borrow money.
- A bare trust appointing a property trustee to hold the property on behalf of the SMSF until the loan is repaid in full, after which time the property trustee must transfer the property to the SMSF trustee.
What are the Requirements?
Most lenders will usually require the members of the SMSF to provide personal guarantees that the SMSF trustee will repay the loan. This means they would be personally liable for the entire indebtedness of the SMSF trustee regardless of the value of the property.
This guarantee can affect any assets personally owned by the guarantors outside of the SMSF if there is a risk of a loan default. Such encumbrances must therefore not be entered into lightly and are highly dependent on the individual circumstances.
Funds borrowed by a SMSF must be secured through a Limited Recourse Borrowing Arrangement (LRBA). This means that the financier’s security for the loan (e.g. a mortgage) can only extend to the property for which the funds have been borrowed and cannot encroach onto any other assets owned by the SMSF.
What are the Limits?
A SMSF may only acquire one property title, or a collection of identical assets with the same market value, per each LRBA. This single acquirable asset rule applies to all real property investments with the exception of multiple titles that can reasonably be identified as a single asset (e.g. an apartment with a separate carpark on title.)
Similarly, the loan monies cannot be used to improve an existing asset already owned by the SMSF, as the funds must only be used to acquire a single asset. While the money can be used to complete basic repairs and maintenance of an asset, trustees are prohibited from using the borrowed funds to alter the original function of the property or allow the subdivision of title.