Self-Managed Super Funds (SMSF) and Property Purchased with Limited Recourse Borrowing Arrangements (LRBA)

Introduction

Self-Managed Super Funds (SMSFs) have gained significant popularity among investors looking to take control of their retirement savings. One of the strategies that SMSF trustees can employ is investing in property, often facilitated by a Limited Recourse Borrowing Arrangement (LRBA). This blog will explore the concept of SMSFs, the process of purchasing property using an LRBA, and the benefits and risks associated with this investment strategy.

What is an SMSF?

An SMSF is a private superannuation fund that members manage themselves, as opposed to traditional super funds managed by financial institutions. The key features of an SMSF include:

• Control: Trustees have direct control over investment decisions.
• Flexibility: Trustees can tailor investment strategies to meet specific retirement goals.
• Responsibility: Trustees are responsible for complying with superannuation laws and regulations.

Investing in Property through an SMSF

Investing in property through an SMSF can be an attractive option for those looking to diversify their retirement portfolio. Property investments can include residential or commercial properties. One way to acquire property within an SMSF is through a Limited Recourse Borrowing Arrangement (LRBA).

What is an LRBA?

An LRBA is a type of borrowing arrangement where an SMSF takes out a loan to purchase an asset, typically real estate. The unique aspect of an LRBA is that the lender’s recourse is limited to the asset purchased with the loan. This means if the SMSF defaults on the loan, the lender can only claim the asset acquired with the borrowed funds, protecting the other assets in the SMSF.

How Does LRBA Work?

1. Set Up a Bare Trust: For LRBA, trustees need to establish a separate trust, known as a bare trust or security trust, which will hold the property on behalf of the SMSF until the loan is fully repaid.
2. Loan Application: The SMSF applies for a loan through a financial institution that offers LRBA products.
3. Property Purchase: The SMSF purchases the property, with the bare trust holding legal ownership while the SMSF holds beneficial ownership.
4. Loan Repayment: The SMSF uses its funds, including contributions and rental income from the property, to repay the loan.
5. Transfer of Ownership: Once the loan is repaid, legal ownership of the property is transferred to the SMSF.

Benefits of Using an LRBA

1. Leverage: An LRBA allows an SMSF to acquire a higher-value property than it could otherwise afford using only its funds.
2. Diversification: Property investment can diversify an SMSF’s portfolio, reducing reliance on traditional asset classes like shares and bonds.
3. Income and Capital Growth: Rental income from the property can provide a steady income stream, while the property itself may appreciate over time, enhancing the SMSF’s overall value.
4. Tax Efficiency: Rental income and capital gains are taxed at a concessional rate of 15% during the accumulation phase and become tax-free during the pension phase*.

Risks and Considerations

1. Complexity: Setting up and managing an LRBA involves complex legal and financial arrangements. Trustees must ensure compliance with superannuation laws and regulations. Contact us to simplify this process for you.
2. Costs: There are additional costs associated with LRBAs, including setup fees, legal fees, loan interest, and ongoing property maintenance.
3. Market Risk: Property values can fluctuate, potentially leading to financial loss if the property market declines.
4. Liquidity: Property is an illiquid asset, which may pose challenges if the SMSF needs to quickly access funds for other investments or member benefits.

Conclusion

Investing in property through an SMSF using an LRBA can be a powerful strategy for building retirement wealth. However, it is not without its complexities and risks. SMSF trustees considering this approach should seek professional advice to ensure it aligns with their financial goals and compliance requirements. With careful planning and management, property investment through an LRBA can enhance an SMSF’s portfolio and contribute to a secure retirement.

*Tax rate will be higher where member’s income is subject to Div 293 tax or member super balance in over 3 million.