SMSF borrowing: Investing in property (what’s OK and NOT OK)

If you run a self-managed superannuation fund, you can invest in all types of real property, including residential property, commercial property, industrial property and even a farm (under certain circumstances).

Before September 2007, the capacity to use borrowed money to purchase an SMSF asset, such as real property, was extremely limited. In September 2007, the rules relating to borrowing within a self-managed super fund were relaxed, although the specific type of borrowing arrangement now permitted within SMSFs is still subject to strict requirements. The borrowing rules were further finetuned in July 2010.

Apart from two exceptions covering short-term cash flow issues within an SMSF, you can only borrow money to purchase an asset within an SMSF by using a limited recourse borrowing arrangement (LRBA). A LRBA means that any recourse the lender has under the borrowing arrangement is limited to the single asset purchased using the LRBA.

Purchasing an asset using a limited recourse borrowing arrangement  (LRBA) is becoming increasingly popular with SMSF trustees seeking to gear an investment portfolio without breaking super’s ‘no borrowing’ rules.

On 14 September 2011, the ATO released a draft SMSF ruling clarifying the rules applying to limited recourse borrowing arrangements, and in May 2012, a final ruling was published: SMSFR 2012/1, “Self-managed superannuation funds: limited recourse borrowing arrangements – application of key concepts.”

The final ruling (as did the draft ruling) deals mainly with real estate and SMSF borowing. The good news for many SMSF investors is that the ATO’s interpretation of what SMSF trustees can do to maintain properties subject to a LRBA provides greater investment opportunities. For example, the ATO has clarified that it is possible to borrow via a LRBA and invest in an older investment property, and to renovate (but not ‘improve’) this property using borrowed money under the existing LRBA, under certain circumstances.

The ATO has also clarified that it is possible to ‘improve’ a property which was purchased using a LRBA, provided that the SMSF trustees do not use borrowed funds to finance the renovation.

SMSF borrowing rules

Although most of this article covers what the super rules permit you to do as an SMSF trustee, you also need to consider whether borrowing to invest is an appropriate investment consideration taking into account the risk and return of the underlying investment and the risk profile of the fund members, the cash flow considerations for the SMSF and whether the super fund is sufficiently diversified to meet its long-term investment objectives.

When a SMSF uses an LRBA to purchase an asset, then the arrangement must satisfy the following conditions:

  • The SMSF uses the borrowed monies to purchase a single asset, or a collection of identical assets that the same market value
  • The SMSF can’t use the LRBA monies to ‘improve’ a purchased asset
  • The SMSF trustees receive the beneficial interest in the purchased asset but the legal ownership of the asset is held on trust (the holding trust)
  • The SMSF trustees have the right to acquire the legal ownership of the asset by making one or more payments
  • Any recourse that the lender has under the LRBA against the SMSF trustees is limited to the single fund asset (including rights to income). Lenders can legally demand an individual to provide a personal guarantee against personal assets
  • Replacing the asset subject to the LRBA is possible only in very specific circumstances.

The ATO has provided further detail on what some of the conditions listed above mean in the ATO’s SMSF Ruling 2012/1: Self-managed superannuation funds: limited recourse borrowing arrangements – application of key concepts, in particular, the meaning of the following terms:

  • a ‘single acquirable asset’
  • maintaining or repairing (which is OK to use borrowed money from the existing LRBA)
  • improving (which is not OK to use borrowed money from the existing LRBA)
  • a replacement asset (negates the existing LRBA, except in limited circumstances)

The ATO has given meanings to the following words:

  • ‘Maintaining’: ordinarily means work done to prevent defects, damage or deterioration of an asset, or in anticipation of future defects, damage or deterioration, provided that the work merely ensures the continued functioning of the asset in its present state.
  • ‘Repairing’: Ordinarily means remedying or making good defects in, damage to, or deterioration of an asset and contemplates the continued existence of the asset. A repair is usually occasional and partial, restoring the function of the asset without changing its character. ‘Repairing’ may include restoration to its former appearance, form, state or condition. A repair merely replaces a part of something or corrects something that is already there and has become worn out or dilapidated through ordinary wear and tear, or is damaged whether accidentally or deliberately by natural causes.
  • ‘Improving’: Significantly altering the state or function of the asset for the better. According to the ruling, “In contrast to repair, an asset is improved if the state or function of the asset is significantly altered for the better, through substantial alterations, or the addition of further substantial features or rights, to the asset…Determining if an acquirable asset is merely restored, or whether its state or function is significantly altered for the better, is a question of fact and degree. In each case it is necessary to consider the qualities and characteristics of the acquirable asset that is subject to the LRBA at the time the LRBA was entered into. Whether the state or function of the acquirable asset has altered significantly for the better is determined objectively and without reference to the actual use to which the acquirable asset is put. Alterations will not amount to an improvement if the state or function of the acquirable asset is only bettered to a minor or trifling extent as compared to the asset as a whole.”

You can read the ruling at your leisure by clicking on the link above, but as a quick reference I list some of the property investing scenarios that the ATO says are OK when using an LRBA, and the scenarios that are NOT OK when using an LRBA.

Note: The ruling, SMSFR 2012/1, applies to arrangements entered into on or after 7 July 2010 (including any arrangement that involves a refinancing since 7 July 2010).

Investment scenarios: what’s OK and NOT OK?

The following scenarios outline when an existing LRBA will continue to apply to an asset, based on the ATO’s SMSF ruling. For example, if a repair is completed on an asset that is subject to an LRBA, that arrangement has not changed simply because a repair has been completed, which means the existing LRBA can continue to be in place (and borrowed moneys from that LRBA can be used to complete the repair).

Note: If the deterioration of an asset occurred before the asset was acquired under an LRBA, and that asset is then repaired using borrowings under the LRBA, the use of those borrowings to repair the asset is OK. The ATO notes however, the greater the state of deterioration at the time of purchase, the greater the chance that any alterations will be regarded as improvements and needed to be funded using SMSF cash, rather than borrowed money under the LRBA. Paragraph 30 of SMSFR 2012/1 states: “Subparagraph 67A(1)(a)(i) provides that borrowings under an LRBA cannot be used to fund improvements. However, money from other sources can be used to improve (or repair or maintain) a single acquirable asset. For example, accumulated funds held by the SMSF may be used to fund the improvements. However, any improvements must not result in the acquirable asset becoming a different asset.”

Key point: If SMSF trustees do decide to improve an asset subject to the LRBA, then must use other SMSF cash to do so, and also must ensure that such an improvement doesn’t change the character of the underlying asset.

1. Repair and maintenance (OK) vs improvement (Not OK)

Project Repair or maintenance (OK under LRBA) Improvement (NOT OK under LRBA)
Residential property
Fire damage to kitchen (cooktop, benches, walls and ceiling) Restore damaged part of kitchen, including adding a dishwasher, even if there wasn’t one there before Added an extension to the kitchen as part of the restoration, or added an external kitchen
Replace guttering (including add leafguard) OK
Paint house OK
Replace fence (including add gate) OK
Install fire alarm (due to council requirements) OK
Install a home automation system , including audiovisual, lighting and security system NOT OK
Install a swimming pool NOT OK
Cyclone damage to roof Replace roof Add a second storey at the same time as replacing roof
Build a pergola NOT OK
Add a second bathroom NOT OK
Replace house destroyed by fire Rebuild comparable house Rebuild house not comparable (although if built from insurance proceeds rather than borrowings, does not affect LRBA)
Farm property
Farm on single title with cattleyards and 4 bores and fencing Replacing a section of the cattleyards or fencing Additional cattleyards (NOT OK)Additional bores (NOT OK)Additional bores or dam (NOT OK)Additional shed (NOT OKAdditional fencing (NOT OK)
Machinery & equipment
Earth-moving equipment Immediately after purchase, part of the LRBA money is used to repair the hydraulics system (OK) A major overhaul of the asset, including replacing all key parts (NOT OK)

Source: Created from information contained in SMSFR 2012/1 (  The copyright of table and contents belongs to Trish Power.

2. Retain asset identity (OK) vs Becomes different asset (NOT OK)

Project Retain identity of existing asset (OK under LRBA) Becomes different asset (NOT OK under existing LRBA)
Vacant block of land on single title Subdivided land resulting in multiple titles
Vacant block of land on single title A residential house is built on that vacant land (even though remains single title) which fundamentally changes character of asset.
A house and land House is demolished following fire and replaced by three strata units.
A house and land Conversion of house into restaurant, with commercial kitchen.
A house and land One bedroom converted into home office
Four bedroom house and land Fire destroys the house and rebuild house with insurance proceeds and SMSF cash, even when add a garage that was not there before
A house and land The following changes are improvements (so couldn’t finance them via the LRBA) but do not change the character of the asset (so would not make the existing LRBA void):

  • Extension adding 2 bedrooms
  • Addition of swimming pool
  • Addition of garage, shed and driveway
  • Addition of garden shed
A house and land Compulsory acquisition of part of front yard for road widening
A house and land Adding a granny flat does not change the character of the property (although the building costs for the granny flat could not be financed via the LRBA).

Source: Created from information contained in SMSFR 2012/1 (  The copyright of table and contents belongs to Trish Power.

3. Single asset (OK) vs Multiple assets (NOT OK)

Project Single asset (OK under LRBA) Multiple assets (NOT OK under single LRBA)
Two adjacent blocks of land Vendor will only sell two blocks together but on separate titles and no legal impediment to being sold separately (NOT OK)
Factory complex on more than one title Entire factory covers three separate titles so cannot be sold separately. .
Farmland with multiple titles Single business but on two titles and no legal or physical impediment to selling titles separately (NOT OK)
Completed ‘off the plan’ apartment Paid deposit in cash, and can enter LRBA to pay the balance.
Vacant block of land, and later decide to build a house Building a house on land involves more than one asset (NOT OK)
House and land Package OK
Apartment with separate car park Although on separate titles, local council does not permit separate sale so single asset.
Serviced apartment and furnishings Requirement to also purchase a furnishing package is a separate asset. Apartment is a single asset and furnishings are another asset (NOT OK)
Option to purchase a house OK, if just the option NOT OK, if subsequently purchases the house because the option is a different asset to the house

Source: Created from information contained in SMSFR 2012/1 (  The copyright of table and contents belong to Trish Power.

For more information, check out the following ATO material:

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  1. Hi,
    Can my SMSF buy a block of land and I’ll buy house on it.
    It would be investment house and I guess shared between SMSF and me in the ratio money invested.

    • Peter (Niche Accounting Solutions) says:

      First up depends wether house is already on the land when you buy it

      Not sure what state you are in but in Victoria your contract is for the land and anything attached to it – so you cant “split” the contract between house and land portions.

      Buying would therefore be “tennants in common” and would be % SMSF and % you – you have talk to your accountant first about structure to make sure you can meet the compliance requirements.

      If you are looking at vacant land and borrowing for land in SMSF and you then pay to build subsequent it is the same as the second example in “2. Retain asset identity (OK) vs Becomes different asset (NOT OK)” as a no under LRBA so fund cant borrow with out trustee breach.

      This question is a regular one so dont be afraid to have your accountant / financial adviser go through the options with you



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