Should I use an LRBA to buy property for my SMSF?
To most people that question will sound like gobbledegook, but you’d be surprised by the number of times I’ve heard it asked at a dinner party.
Of course, Australians love investing in good old bricks and mortar. Almost one in 10 owns an investment property.
Here’s something else more Aussies are embracing – the self-managed superannuation fund (SMSF). There are more than half a million of those, holding assets worth a cool half a trillion dollars. The link? This year 30 per cent of new SMSFs were established specifically to buy property.
The reasons? Set up correctly, they enhance the chance of maximising your retirement funds. There can be considerable tax benefits, and they provide added control of and protections for your assets. You can also bypass normal contribution limits to put more into your self-managed super.
What is a limited recourse borrowing arrangement?
Introduced in 2007 as “Investment Warrants”, some hefty legislation changes saw them become LRBAs as part of the Simpler Super legislation in 2010. Before the law change, SMSF trustees could not borrow to invest. A limited recourse loan is designed to enable you to borrow or gear your super into property and certain other assets, with strict conditions.
For instance, an LRBA can only be used to buy a single asset. To date, most self-managed funds have opted to invest in commercial property over residential property. But the arrangement isn’t exclusive to property. A fund can also invest in shares or certain types of managed funds.
Should you be considering an LRBA?
In the right circumstances this arrangement can be a terrific opportunity for an SMSF.
Not surprisingly, the prospect of being able to transfer business premises into a fund is attractive for many small and medium-sized business owners.
They release equity now and can take advantage of superannuation tax concessions later – 10% if the property is sold before the pension phase, or no tax at all after it kicks in.
Super is also a protected asset in the event of bankruptcy or any other business deterioration – another big attraction.
In cases like this, business owners take control of their Super, invest in the assets they want and make the fund work harder for them. It’s a compelling proposition – a property earning market rate rent with concessional or even no capital gains tax to pay in future.
But, as always, there are risks. Commercial properties typically don’t enjoy the growth of their residential counterparts and if a business outgrows the premises, you need to consider the consequences of selling in order to fund the next move. Understanding the complex regulatory environment around self-managed funds can also be a challenge.
The Australian Tax Office (ATO) enforces strict rules and penalties around SMSF property sales and transfers.
Consider too unexpected events like the death of incapacitation of a fund member. That might mean other members have to sell the asset to pay out required lumps sum benefits. The knock-on effects can be considerable; from reduced returns as a result of the forced sale to liability for capital gains tax because the pension phase – when no tax is due – has not been reached.
For these reasons and more, taking out the right insurance is vital.
Important points to be aware of when considering an LRBA
- Banks will typically loan less than a personal loan – and the interest rate will likely be higher.
- The Super fund pays all running costs and expenses, and you need to make sure there’s enough liquidity to meet the loan repayments.
- If you do default, the bank can only seize the asset that is the subject of the loan – and not any other fund assets.
- You or your family can’t live in a property owned by your SMSF.
- You can use it as your place of business and pay market rate rent directly to your fund.
- You can use borrowed funds to maintain the property, but not to make improvements.
- If your loan is not set up correctly, you could be forced to sell the property – and risk a loss to the SMSF.
- Tax losses can’t be used to offset against your taxable income outside the fund.
Is the writing on the wall for LRBAs?
Property prices in cities like Melbourne and Sydney have surged to record levels recently, prompting concerns about a bubble. LRBA’s have been getting some of the blame, unfairly in our opinion. SMSF investment in residential properties has increased in recent years, but still accounts for just over three per cent of all self-managed funds’ assets.
Still, the Reserve Bank of Australia has voiced concern about heavy promotion of SMSF property investments, and increasing “speculative activity”. Former prime minister Paul Keating believes there should be limits to the availability of debt to SMSFs.
Not surprisingly the big superannuation funds, spooked by the rise of their self-managed counterparts, are also lobbying against LRBAs. A Financial Services Inquiry is currently looking at all these issues, and although we’d be surprised if LRBA’s are banned, more restrictions may be on the cards.
Make sure you get the best advice
Under recent legislation, financial advisers are required to act in clients’ best interests and ensure advice is appropriate to their circumstances. Still, some concerns about LRBAs are legitimate. You should always be very wary when an estate agent or developer linked to the property you are interested in offers to set up the loan.
They’re highly unlikely to be acting in your best interests. And remember, an LRBA is a loan that will cost money to establish, and just one factor in the overall investment decision. In the right circumstances, they represent a tremendous opportunity. But it’s absolutely vital to get specialist help to find out if such an arrangement is right for you, and to avoid the potential pitfalls that can come back to bite you years down the line.
Get it wrong at the outset and you might be hit later by a big tax or stamp duty demand. In extreme cases, maximum fines of up to $220,000 can be applied for breaches of the rules.
LRBAs could be the route to a Super windfall, but with the current political and regulatory climate they may not be around in their current form for much longer. So you need to act fast.
You also need to make sure you get the best specialist advice. Don’t risk nasty surprises when you decide to sell your investment. Our highly qualified advisers are experts in this complicated field and can help you decide if an LRBA is right for you, and then hand hold you through the entire experience.