SMSF property and LRBAs: the borrowing rules every Australian trustee should know

Borrowing inside an SMSF to buy property is allowed, but only through a very specific structure called a limited recourse borrowing arrangement (LRBA). Every part of the structure exists to satisfy the SIS Act's prohibition on most fund borrowing — get a step wrong and the whole arrangement can be unwound by the ATO.

The basic structure

Under section 67A of the SIS Act, an SMSF can borrow only if all of these conditions are met:

• The borrowed money is used to acquire a single acquirable asset
• The asset is held in a separate holding trust (often called a 'bare trust') with a custodian trustee
• The SMSF has a beneficial interest in the asset and the right to acquire legal title once the loan is repaid
• The lender's recourse on default is limited to the asset itself — other fund assets are protected

Single acquirable asset

An LRBA can fund only one asset, or a collection of identical assets with the same market value (e.g. a parcel of identical shares). For property this usually means one title — two adjoining titles generally need two separate LRBAs, even if you intend to develop them together. The ATO has detailed guidance in SMSFR 2012/1.

What you can and can't do to the property

Borrowed money can be used to maintain or repair the property (returning it to its original state), but cannot be used to improve it (changing its character — e.g. adding a new bedroom or building a granny flat). Improvements can be made using the fund's own cash, but the asset's character can't change so significantly that it becomes a 'different' asset while the LRBA is on foot.

Related-party loans and PCG 2016/5

If your SMSF borrows from a related party (a member, relative, or family company) instead of a bank, the loan must be on arm's-length terms or the income from the asset becomes non-arm's-length income (NALI), taxed at 45%. The ATO publishes safe-harbour terms in PCG 2016/5 covering interest rate, loan-to-value ratio, term, and repayment frequency for both real property and listed shares. If you don't meet the safe harbour, you must demonstrate the terms are still genuinely arm's-length.

What auditors check on an SMSF LRBA

• A signed bare trust deed dated before settlement
• Title and contract clearly in the holding trustee's name
• Loan agreement consistent with PCG 2016/5 (or independent evidence of arm's-length terms)
• Evidence the property is being maintained, not improved with borrowed money
• Rental income paid to the SMSF, not the holding trust or a member

Residential vs commercial

Residential property bought under an LRBA cannot be acquired from a related party and cannot be rented to a related party. Commercial property used wholly and exclusively in a business — 'business real property' — can be acquired from and leased back to a related party at arm's-length rent, which is why so many small business owners use this structure.

Source: Australian Taxation Office — LRBA guidance, SMSFR 2012/1, PCG 2016/5 (ato.gov.au). LRBAs are complex; get specialist advice and a registered SMSF auditor's review before settlement.