SMSF Strategy Guide: Online Library

Investing rules

SMSF Education
Smsf strategy guide: Online library

Borrowing in a SMSF (LRBAs)

BACKGROUND

A key responsibility for SMSF trustees is to ensure the fund does not borrow money. Now whilst this is true in terms of being a general concept, there are in fact a number of exceptions to the rule.

THE EXCEPTIONS

These exceptions include:

  1. The trustee can borrow to pay a benefit to a member / beneficiary only if the trustee would otherwise be unable to make the payment. The total amount borrowed must not exceed 10% of the value of the assets of the fund and must be repaid within 90 days.
  2. The trustee can borrow to cover settlement of a transaction to acquire a security but only if at the time the relevant investment decision was made, the borrowing was not expected to be needed and the period of the borrowing does not exceed 7 days. The total amount borrowed must not exceed 10% of the value of the assets of the fund.
  3. Limited recourse arrangements – The trustee can borrow to purchase a single acquirable asset provided the specific rule for limited recourse borrowing arrangements are met.

It is these Limited recourse borrowing arrangements that are of most interest
to SMSF investors in terms of implementing an actual investment strategy.

LIMITED RECOURSE BORROWING ARRANGEMENT

Limited recourse borrowing arrangements have the following
characteristics:

  • The money borrowed is used to acquire a single asset, including expenses incurred to obtain the borrowing, repairs or interest accrued if refinancing.
  • The acquired asset is held in trust and the SMSF receives both beneficial interest and the right to acquire the legal ownership of the asset (or replacement asset) through the payment of instalments.
  • The lender and/or any other person (including a guarantor) has limited recourse against the trustee. If the trustee defaults on the loan, the amount that can be recovered by any other party is limited to the value of the asset. This applies to the recovery of the borrowed amount as well as related fees and charges.
  • The trustee is able to purchase the asset. That is, the purchase is not prohibited under the legislation.

This graphic illustrates how a SMSF borrowing works.

Starting from the top left, we have:

  • the lender (which is generally the bank) lending money to the SMSF, who is the borrower.
  • The SMSF finds the asset it wishes to purchase. This asset is held in a special type of trust, known as the holding trust and has its own trustee.
  • The asset is held in the name of the holding trust trustee, as trustee for the holding trust.
  • Income from the asset is paid to the SMSF.
  • The SMSF makes repayments back to the lender. Finally, if everything goes pear shaped, then the lender only has recourse to the purchased asset, not the other assets of the SMSF.

We highly recommend that if you are looking at using a limited recourse borrowing arrangement in your fund, that you seek professional assistance given the complexities of the arrangement.

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