A Limited Recourse Borrowing Arrangement (LRBA) is a loan structure that allows a Self-Managed Super Fund (SMSF) to borrow money to purchase property.
The loan is secured against the acquired property, but importantly, the lender’s recourse is limited to the property itself. If the SMSF defaults on the loan, the lender can only claim the property, not any other SMSF assets.
This feature provides crucial protection for the fund’s other investments.
To comply with the Superannuation Industry (Supervision) Act 1993 (SIS Act), the purchased property must be held in a separate bare trust (also known as a holding trust) until the loan is fully repaid.
What is a Bare Trust?
A bare trust is a legal structure set up specifically to hold the acquired asset on behalf of the SMSF while the loan is being repaid. While the SMSF is the beneficial owner of the property, the bare trust holds the legal title to the property.
Key Features of a Bare Trust:
- The trustee of the bare trust must be separate from the SMSF trustee.
- The SMSF has full beneficial ownership rights, meaning it receives all rental income and bears all expenses related to the property.
- Each property acquired through an LRBA requires a separate bare trust; multiple properties cannot be held in the same trust.
- Once the loan is repaid, the legal ownership of the property must be transferred from the bare trust to the SMSF.
Key Rules and Compliance Considerations
Investing in property through an LRBA comes with strict regulatory conditions. These are outlined in the SIS Act and the Superannuation Industry (Supervision) Regulations 1994 (SIS Regulations).
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The Single Acquirable Asset Rule
Under Section 67A of the SIS Act, an LRBA can only be used to acquire a single property or a group of identical assets with the same market value (such as a parcel of shares in the same company). After the property is purchased, borrowed funds cannot be used for major improvements—only repairs and maintenance are permitted.
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The Property Must Align with the SMSF Investment Strategy
Before proceeding with an LRBA, SMSF trustees must ensure that the property investment aligns with their fund’s investment strategy, considering risk, return, liquidity, diversification, and the ability to meet ongoing obligations.
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No Personal Use or Related Party Transactions
The property cannot be used by fund members, trustees, or their relatives. Additionally, an SMSF cannot purchase residential property from related parties unless it qualifies as business real property (e.g., commercial property leased at market rates).
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Loan Structure and Lender Requirements
Many lenders require SMSFs to provide larger deposits (e.g., 30–40%) due to the limited recourse nature of the loan. Interest rates are typically higher than standard home loans. Loans must be on commercial terms, especially when borrowing from related-party lenders, to avoid tax penalties under the Non-Arm’s Length Income (NALI) rules (Section 295-550 ITAA 1997).
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Tax Implications of an LRBA
– Rental Income & Deductions: Rental income is taxed at the concessional SMSF tax rate of 15%.
– Capital Gains Tax (CGT): If the property is held for over 12 months, SMSFs can benefit from a 33% CGT discount. If the SMSF enters pension phase, no CGT is payable.
-Non-Arm’s Length Income (NALI): If the loan or rental arrangements are not at market rates, the income may be taxed at the highest marginal rate of 45%. -
Prohibited Encumbrances and Refinancing Restrictions
Under SIS Regulations (Regulation 13.14), SMSFs cannot place charges or encumbrances over fund assets, except when using an LRBA. Refinancing is permitted but must comply with the same strict borrowing conditions as the original loan.
Pros and Cons of LRBAs
✅ Benefits of Investing in Property with an LRBA
- Asset Growth within Super: Property investment can generate rental income and capital growth in the tax-efficient SMSF environment.
- Risk Containment: The lender’s recourse is limited to the acquired property, protecting other SMSF assets.
- Tax Advantages: Concessional tax rates on rental income and capital gains, especially during the pension phase.
⚠️ Risks and Challenges
- Higher Deposit & Interest Rates: Lenders require larger deposits and charge higher interest rates than traditional property loans.
- Limited Liquidity: Property is a less liquid asset, which could create cash flow challenges for the SMSF.
- Strict Compliance Requirements: Breaches of the SIS Act can lead to severe penalties, tax consequences, or the loss of SMSF compliance status.
- No Personal Use: Unlike direct property ownership, fund members cannot use the property, limiting flexibility.
Is an LRBA Right for Your SMSF?
An LRBA can be an effective tool for SMSF trustees seeking to invest in property using borrowed funds. However, the complex rules, compliance obligations, and financial risks mean professional advice is essential.
Get in touch with our SMSF team if you’d like to discuss purchasing property through your SMSF.
