02 Sep SMSF Borrowing and Investment Rules: What you need to know
Taking out a loan to invest in assets such as property can enable the members of a Self-Managed Superannuation Fund (SMSF) to increase the fund’s potential for financial growth. Fortunately since 2007 it has been allowable for SMSFs to borrow funds to invest in assets, providing they adhere to the rules and restrictions.
General asset investment rules
One of the main aspects of asset investment through an SMSF, whether from borrowed funds or not, is that the asset must not be used for any current benefit of the members or related parties, but must only exist within the fund for the sole purpose of providing retirement benefits for the members (known as the ‘sole purpose’ test).
To provide an example, SMSF members sometimes choose to invest in collectibles as part of their fund’s portfolio. Examples of this include artwork, antiques, jewellery, rare coins and other rare items, vintage cars, wines, spirits, and recreational boats.
Applying the sole purpose test to these assets means they cannot be used for personal purposes or put on display in any of the members’ private homes – although it may be possible to lease them to a third party (such as to a gallery).
When it comes to SMSF borrowing however, there are some specific rules to follow – which we explain further below.
SMSF borrowing rules
Types of asset:
The types of assets an SMSF can borrow for investment include property (commercial or residential), farms, shares, factories or land.
Sole purpose test:
The assets must meet the ‘sole purpose’ test as outlined above – that is, they exist solely to provide a retirement (and not a current) benefit. This means that an investment property cannot be used by or rented to any fund member or their related parties, such as family members. In addition, any income generated from the property must be channelled back into the SMSF and not used for a personal purpose.
Limited Recourse Borrowing Arrangement (LRBA) rules:
The investment must adhere to the rules under a Limited Resource Borrowing Arrangement or LRBA. This states that only one asset (or collection of identical assets such as a parcel of shares) can be acquired under a single borrowing arrangement. The asset also remains as security for the loan and must be held in a separate trust until the loan is paid out.
Under the LRBA the asset cannot be ‘improved’ on using borrowed funds. This means that a property cannot substantially changed – such as by adding an extension or a swimming pool – using the borrowed money. Repairs and maintenance on a property are allowable, in order to prevent deterioration or to restore a damaged or burnt house to its former state.
It may be possible however to make some improvements using other SMSF funds, as long as it does not substantially change the character of the asset.
The LRBA rules are quite complex and not always cut-and-dried, and may be subject to interpretation. For instance the difference between what constitutes either ‘repairs’ or ‘improvements’ is not always clear cut.
Before implementing investment property strategies through an SMSF we recommend getting financial advice and tax advice from experienced specialists.
If you’d like some more information or to contact our team of independent financial advisers and property specialist tax accountants, Visit – www.Chan-Naylor.com.au