Borrowing and SMSF
A self-managed superannuation fund (SMSF) is generally prohibited from borrowing money. However, in limited circumstances, the borrowing is allowed where the borrowing is a limited recourse borrowing arrangement.
Take the following example for instance. Tony runs his business from a rented commercial property which is currently up for sale. He would like to purchase the property himself but does not have sufficient funds to do so. However, he does have a rather large balance in his SMSF. Can his SMSF take advantage of the funds that it has to purchase the property? The answer is yes. In this article we set out the steps on how to achieve this.
- Tony will need to set up a bare trust to purchase the property. The bare trust will hold the property on trust for Tony’s SMSF until the loan for the property is fully repaid. A related company is typically set up to act as the bare trustee for the purchase.
- All monies required for the purchase of the property will need to come from Tony’s SMSF. This means that any borrowing arrangement required to purchase the property must be entered into by Tony’s SMSF trustee with the bank (or other third party lender).
- After the loan is fully repaid, Tony’s SMSF has the right but not the obligation to acquire legal ownership of the property from the bare trustee.
- In the event of default under the loan, the rights of the lender (e.g. the bank) will be limited to the asset purchased by the loan funds. i.e. The bank will not have any recourse to the other assets held in Tony’s SMSF, hence the name “limited recourse borrowing arrangement.”
- Tony’s business must pay market value rental for renting the commercial premises.
The above borrowing arrangement has given SMSF trustees access to greater investment opportunities. However, it may not necessarily be a suitable strategy for everyone. You will need to check that the above mentioned borrowing arrangement is suitable for your SMSF’s investment strategy and risk profile, and of course, the governing rules of your SMSF needs to permit your SMSF trustee to borrow.
The initial setup of the arrangement can be frustrating. As banks do not have recourse to any other assets of the SMSF in the event of default, they will undoubtedly request for a significant amount of documentation to prove that the loan repayments can be met before approving the loan. However, if you are prepared to put in the initial efforts with setting up the arrangement for the property purchase, it can prove to be a rewarding investment, as
- The SMSF is only taxed at 15% compared to marginal rates if the property was purchased in personal names;
- Capital gains on the eventual sale of the property is only 10% if the property is held for more than 1 year by the SMSF; and
- Once the SMSF is in pension phase, any income and capital gains made in the SMSF will be tax free in the fund.
If you have any queries on the above or wish to find out how to put a limited recourse borrowing arrangement in place for your SMSF, please do not hesitate to contact our office on (02) 9713 1199.