Many SMSF members are thinking about setting up an SMSF to purchase SMSF Property. Once we let them know that you cannot purchase a beach house and live in it during the holidays, the discussion points to how to borrow to invest in SMSF Property and how to structure the SMSF Property in accordance with Superannuation Regulations.
Since 2007, SMSFs have been allowed to borrow to purchase property under a “Limited Recourse Borrowing Arrangement” (LRBA). Given the high regulation of SMSF’s there was not a significant take up of LRBA’s with uncertainty over key areas of the SMSF Borrowing process.
As a result, in 2012 the ATO released a ruling SMSFR 2012/1 (“ruling”) to address key areas of contention including:
- Improvements v repairs
- Improvements and replaceable assets
- What is a single acquirable asset
- Property development and off the plan purchases (not covered in this article)
In 2014, even with an in-depth explanation in SMSFR 2012/1, a number of SMSF members are not clear on what is a borrowing or a repair and whether you can use borrow funds to improve an asset.
Put simply, the ruling now enables a property purchased under a LRBA to be renovated or improved, provided the following conditions are met:
- The source of funds for the improvements come from within the SMSF (i.e. not borrowed)
- A replacement asset is not created.
What does this mean?
Lets attempt to summarise some of the key issues with a FAQ series without the legal ‘lingo’ attached:
What is a single acquirable asset?
The property should be on one title, if a car park for example is on a second title, this may not be a single acquirable asset and you should seek advice (refer example 4 of the ruling). If you have purchased a house on one title you cannot add the house next door to the LRBA which is on a separate title.
What does maintain, repair and improvement mean?
‘Maintaining‘ means work done to prevent defects, damage or deterioration of an asset, or in anticipation of future defects, damage or deterioration. Example is a fence is replaced with modern equivalent materials
‘Repairing‘ means remedying or making good defects in, damage to, or deterioration of an asset and contemplates the continued existence of the asset. Example is a guttering is replaced with modern equivalent materials.
Improvement means significant altering or substantial features or rights to an asset. Example is pergola or garage added to an existing property under a LRBA.
Can I use borrowings to ‘repair’ a property under a LRBA?
If deterioration of the property occurred before the asset was acquired under an LRBA and the property is subsequently repaired using borrowings under the LRBA, the use of borrowings is allowed. However, as the asset deteriorates, the more like that alterations can be regarded as improvements. Be sure that drawdowns are used for the property under a LRBA not an existing SMSF property. This indicates that over time repairs may not be black and white and may favour the purchase of a new property over an older property.
Can I use borrowings to ‘improve’ a property under a LRBA?
Borrowings cannot be used to fund improvements however, other sources such as cash in the SMSF can used to fund improvements. It is important that any improvements cannot result in an asset becoming a different asset.
How does this influence my SMSF Property decision?
Based on the above, if you are looking to purchase an older property and renovate, you need to budget the renovation costs and cover from your SMSF cash not borrowings. If you are one to purchase and sub-divide a property, an LRBA may not be right for you and given the long-term horizon of SMSF Property in addition to depreciation benefits, a new rather than old house may be suitable depending on your investment strategy.
Taking into account the above limitations, there is still a very large scope for what can be done to a property under a limited recourse borrowing arrangement. Please refer to the ruling for further examples and ensure you seek advice from a SMSF Specialist before proceeding with a repair or improvement or in considering the definition of a single acquirable asset.
This article was written by Ivan Filipovic – Director at Redwood Advisory
Disclaimer: The content has been prepared without taking account of the objectives, financial situation or needs of a particular individual and does not constitute financial product advice.