UNDERSTAND THE RULES AROUND BORROWING TO INVEST IN ASSETS FOR YOUR SMSF
Your SMSF can borrow to invest in any type of asset that is otherwise available to be acquired, including residential and commercial property, shares and managed funds. You simply need to ensure the borrowing arrangement satisfies each of the following conditions.
1. The loan must be a Limited Recourse Borrowing Arrangement (LRBA)
The loan used to purchase the asset must be of limited recourse, which means if you default on your loan, the lender only has a right to the asset used as security for the loan but no other assets held in your SMSF.
2. The borrowed money must be applied to the purchase of an asset
You can only use borrowed funds to invest in a single asset, or the collection of identical assets that have the same market value. Examples of single assets include a block of land, a single property or a
parcel of identical shares in the same company. If the land is subdivided or the shares are from a number of different companies, they would be treated as separate assets and you would be breaching the Australian Tax Office (ATO) borrowing rules.Expenses incurred in the purchase and maintenance of this asset, as well as loan expenses such as stamp duty and establishment fees, can also be paid using borrowed funds.
3. The asset must be held in a separate security trust until the loan is paid
The asset will be held in a separate trust until the loan is paid and SMSF trustees receive any investment returns earned by the asset during this time. The SMSF is also responsible for any interest payments required to maintain the loan. Because the value of the asset can’t be accessed until the loan is repaid, many SMSF trustees use LRBAs to invest in residential or commercial property over other asset classes.
4. The SMSF has the right to acquire the asset once the loan is paid
Once your SMSF has paid off the loan, you have the right to move the property out of the holding trust and acquire legal ownership of the asset if you choose. Although you can make repairs or maintain the asset during the loan period, you can’t improve or replace the asset in any way until the loan is paid. This means you can’t trade shares while the loan is in place, as it’s classified as replacing the asset during the loan period. This is another reason why property is a popular option for SMSFs who use borrowed funds to invest.
5. The SMSF is responsible for making loan repayments when they are due
As trustee of an SMSF, it’s important to understand the financial position of your SMSF and ensure there is sufficient cash flow to make loan repayments when they are due. You can use investment returns from other assets and member contributions to pay the loan, however you need to be confident that member contributions will continue at the required level to pay off the loan. If you are having trouble making loan repayments, it’s possible to liquidate other assets to fund the gap or refinance the asset to help you meet your loan obligations. You should consider appropriate insurance, including life and disability cover to protect you if something unexpected occurs and you cannot repay the loan. General insurance is also recommended, to protect the asset against damage.
If you default on the loan, the lender can only claim the asset that is being used as security for the loan. They can repossess the asset or force the loan guarantor to fund the shortfall, if one has been provided. For this reason, it’s important that any payments to the SMSF by loan guarantors are clearly classified as member contributions and not loan repayments, so they are protected in the event of a default. There are also legal and regulatory consequences for defaulting on a LRBA.
IS BORROWING RIGHT FOR YOU?
As with any investment loan, it’s not suitable for everyone. If you have secure employment, sufficient cash flow in your SMSF, a tolerance for risk and reasonable investment experience, you may wish to consider borrowing to invest. Lenders often prefer to offer LRBAs on assets that produce income to repay the loan, such as residential or commercial property.
Before applying for an LRBA, talk to your SF Wealth financial adviser to work out if the investment aligns to your overall investment strategy and will satisfy all borrowing conditions.
This information is general in nature and does not take into consideration your personal circumstances. Talk to your SF Wealth financial adviser for SMSF advice that’s right for you.
