How To Know If LRBA Is Right For You
Property can be a great investment strategy for your super fund and an LRBA can make it possible. That said, it’s important to know the risks and requirements before you do anything!
As property investment within SMSFs has increased in recent years, a lot of dodgy wealth building seminars and property spruikers have seen it as an opportunity to make money off SMSF investments.
Pauline Vamos of the Association of Superannuation Funds Australia (ASFA) said last year that:
“For some time now ASFA has been concerned about the growing number of people being targeted by schemes which offer attractive incentives up-front at the expense of good retirement outcomes down the track”.
What typically happens is an ‘advisor’ lures investors into making unwise property investment decisions with incentives that may be entirely unrelated to the property they’re investing in.
Ten years down the track and these investors are lucky if they see an average return. (Meanwhile, it will probably seem like every other investor has outperformed the market!)
But this shouldn’t turn you off property investment.
The successes of property investments are well documented, which may explain why the number of limited recourse borrowing arrangements (LRBA) has increased by over 1,700% between June 2009 and June 2014. It is important however, to consider carefully whether an LRBA is right for you.
What is an LRBA?
An LRBA allows an SMSF to take a loan to purchase asset(s) that are then held in a separate trust. The returns on the investment go into the SMSF but if the loan defaults, there is no recourse to other assets within the SMSF.
Nevertheless, it is crucial that you comply with the LRBA regulations to ensure that it is set up properly. From the borrowing arrangements to purchasing the property, there are strict compliance obligations and if these aren’t met, you run the risk of the SMSF being deemed non-compliant and losing its concessional tax status. As of July 1, 2014, the trustee can also be personally fined.
The risks of investing in property
The following risks I’ve taken directly from ASIC. I’ve built my business (and my wealth) on the success of property investment, but as with any wealth investment strategy there are risks. It’s important that my clients be aware of these before they make a purchase.
- Higher costs– SMSF property loans tend to be more costly than other property loans which must be factored into your investment decision.
- Cash flow– Loan repayments must be made from your SMSF which means your fund must always have sufficient liquidity or cash flow to meet the loan repayments.
- Hard to cancel– If your SMSF property loan documentation and contract is not set up correctly, unwinding the arrangement may not be allowed and you may be required to sell the property, potentially causing substantial losses to the SMSF.
- Possible tax losses– Any tax losses from the property cannot be offset against your taxable income outside the fund.
- Cannot borrow to improve the property– Borrowed funds can be used to maintain a property but cannot be used to improve a property.
Also worth mentioning is the risk in setting up the loan. It is common for trustees to get very simple things wrong, for instance putting the name of the individuals on the property contract rather than the SMSF. Or not establishing a trust before the property is purchased. All of these little, seemingly harmless errors can cost you money and cause a lot of grief.
What you can’t do
There are various regulations about what you can and can’t do with your property. For instance, you can’t…
- live in your property. The ATO is strict in saying that the property must be at ‘arms length’ until retirement
- Rent to a family member.
- purchase the property as an investment for another family member
- purchase the property from a related party i.e. family
You can, however…
- purchase a commercial property. If you own a business, your super fund could even purchase the premises and (rent it from the SMSF) then all rent that you pay would go into the super.
- Renovate, repair and even improve the property within certain guidelines relating to the funds you use to make improvements.
- Develop the property – again, within certain guidelines
- buy a retirement home – you can purchase a property with the intention to live in it once you retire.
There are a lot of ‘Yes… BUT’ or ‘No..BUT’ answers I give to my clients, which is why it is valuable to get advice before you decide to set up an LRBA. If you would like to find out more, please feel free to contact us.
