Understanding Limited Recourse Borrowing Arrangements (LRBA) in SMSFs for Property Investment

By Jaye Mankelow

For those considering property investment through a Self-Managed Superannuation Fund (SMSF), a Limited Recourse Borrowing Arrangement (LRBA) can be a strategic financing option. LRBAs allow SMSFs to borrow funds for property acquisition while limiting the fund's liability to just the asset purchased, making it particularly appealing for business owners and long-term investors. This article provides a guide to LRBAs, covering their structure, tax benefits, regulatory considerations, and potential for business property acquisition.

What is a Limited Recourse Borrowing Arrangement (LRBA)?

An LRBA is a financial arrangement allowing an SMSF to borrow funds to acquire a single asset or group of identical assets, typically real estate, with a limited recourse condition. In this structure, the lender's recourse is limited solely to the asset acquired with the borrowed funds, which means that, in case of default, the lender can only claim against the specific asset within the LRBA, not against the SMSF's other assets.

• Structure of an LRBA: The LRBA setup involves the SMSF, a lender, and a separate trust known as a Bare Trust. The Bare Trust holds the legal title to the acquired property until the SMSF pays off the loan, at which point the asset is transferred directly to the SMSF.
• Purpose: LRBAs offer SMSFs a way to leverage their funds, allowing them to access larger investment opportunities—such as property acquisitions—that might otherwise require greater immediate cash reserves.

Regulatory Guidelines on Minimum Fund Balances for LRBAs

While there is no strict legal minimum balance for SMSFs to engage in an LRBA, regulatory bodies like ASIC and the ATO typically expect SMSFs to have sufficient funds to manage the ongoing costs and risks of borrowing.

• Minimum Suggested Balances: A general rule of thumb is that SMSFs should have a minimum balance of around $200,000 to $300,000 before considering an LRBA, depending on the fund's other assets, liquidity, and risk tolerance. This ensures the SMSF has adequate resources to cover loan repayments, property maintenance, and other obligations without jeopardising members' retirement benefits.
• Fund Liquidity Requirements: SMSFs must maintain enough liquidity to cover costs like loan repayments, management fees, and potential vacancies (for rental properties). Trustees should assess their fund's cash flow to determine if an LRBA is financially sustainable.

Using an LRBA for Business Owners to Acquire Business Property

For business owners, using an LRBA to acquire business premises within an SMSF can be an effective strategy for both asset growth and tax efficiency. Under this approach, the SMSF purchases the property, which is then leased back to the business at market rates. This setup offers several advantages:

• Asset Ownership and Control: The business property is owned by the SMSF, which provides a layer of asset protection and ensures that the property remains within the owner's control, even if business circumstances change.
• Tax Deductible Lease Payments: The business pays rent to the SMSF at market rates, which is deductible as a business expense. Meanwhile, the SMSF benefits from rental income, which is taxed at the concessional superannuation tax rates.
• Future Retirement Asset: The property remains an asset of the SMSF, contributing to the fund's overall growth. Upon retirement, business owners benefit from a potentially income-generating asset within their super fund, or they may choose to sell the property within the SMSF with capital gains tax concessions.
• Preserving Working Capital: By acquiring business property through an SMSF and leasing it back, business owners can avoid tying up substantial capital in real estate, allowing them to reinvest in business operations and growth.

Example: A small business owner establishes an LRBA within their SMSF to purchase an office building used by their business. The business pays rent to the SMSF, providing a steady income stream for the fund and offering a tax-deductible expense to the business. When the loan is paid off, the SMSF fully owns the property, providing asset stability and potential retirement income.

Tax Benefits of Using an LRBA

Investing through an LRBA provides tax advantages aligned with the SMSF's tax environment, enhancing the appeal of long-term property investment:

• Concessional Tax Rates: In the accumulation phase, SMSF income is taxed at 15%, much lower than individual rates. In the pension phase, this tax rate drops to 0%, meaning rental income and capital gains can become tax-free.
• Capital Gains Tax (CGT) Concessions: If the SMSF holds the property for over 12 months, it qualifies for a one-third CGT discount, reducing tax on any capital gains when the SMSF sells the property.
• Deductions on Borrowing Costs: SMSFs can claim tax deductions on interest expenses related to the loan, enhancing the tax efficiency of the property investment.

Compliance Requirements for SMSF Trustees

To comply with Australian Tax Office (ATO) regulations, SMSF trustees must meet several requirements when setting up and managing an LRBA:

• Arm's Length Loan Terms: Loan terms must be commercially viable (arm's length), mirroring terms that would be offered by a third-party lender. Non-arm's length income (NALI) provisions can apply if terms are more favourable than those commercially available.
• Single Acquirable Asset Rule: The LRBA can only finance a single acquirable asset or a group of identical assets with the same market value (e.g., a single property or shares in the same company). Mixing asset types within one LRBA is not permitted.
• No Alterations to the Property: The property acquired under an LRBA cannot be significantly altered until the loan is fully repaid. Any improvements that change the character of the property may trigger compliance issues.
• Trustee Obligations: Trustees must ensure that LRBA-related property is consistent with the SMSF's investment strategy. They are also required to regularly review and update the investment strategy, taking into account the risk associated with the borrowed asset.

An LRBA can be a valuable strategy for SMSFs to invest in property, especially for business owners who wish to acquire and operate out of their business premises. With the support of a Bare Trust, LRBAs offer tax advantages, asset growth potential, and an efficient means of leveraging SMSF assets. However, due to the compliance and risk considerations involved, it's crucial for SMSF trustees to carefully evaluate this approach within the context of the fund's long-term strategy.

Aspira's team of SMSF specialists, accountants, and financial planners is here to support you in setting up and managing your SMSF, ensuring compliance, and structuring investments like LRBAs to align with your long-term goals. Whether you're looking to invest in property, streamline tax benefits, or strengthen your retirement strategy, our dedicated professionals will guide you through each step with tailored expertise.

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