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Home / SMSFs / SMSF investing / What are the SMSF borrowing rules?

What are the SMSF borrowing rules?

August 6, 2020 by Penny Pryor 1 Comment

Reading time: 9 minutes

On this page

  • Borrowing to invest
  • How does SMSF borrowing work?
  • Single acquirable asset
  • Repair or maintenance versus improvement
  • Intermediary LRBA update
  • Other investments
  • Refinancing

A relaxation of rules around borrowing in self-managed superannuation funds (SMSFs) over a decade ago now means that SMSFs can borrow to invest in some circumstances. Although loans were originally allowed for borrowing to invest in shares, restrictions around the rules mean that in most cases they are now used for property assets. Legislative changes earlier this year also made it possible for SMSFs to acquire property with limited recourse borrowing arrangements (LRBA) using a holding trust.

There are also some other limited circumstances when SMSFs can borrow to invest, as we outlined in our SMSF investment rules article.

To recap, your SMSF can borrow money for a short period of time if that amount is less than 10 per cent of the fund’s total assets. Those circumstances are:

  • A maximum of 90 days to meet benefit payments or to pay an outstanding surcharge liability; or
  • A maximum of seven days to cover the settlement of security transactions. You can also only do this if you did not think you would need to borrow funds when you bought the securities.

These transactions need to be on an arm’s-length basis – i.e. at an appropriate market rate of return.

“The ATO has no guidelines if the fund has borrowed from a related party for these purposes, compared to borrowing for limited recourse borrowing purposes. As a guide you could use the safe harbour interest rate for LRBAs or other ATO benchmark rates, which are in the vicinity of 5% to 6%. You could also put the terms to the ATO to see whether the loan is on an arm’s-length basis,” Graeme Colley, executive manager, SMSF Technical & Private Wealth at SuperConcepts says.

Borrowing to invest

The only other time you can borrow within your SMSF is via limited recourse borrowing arrangements (LRBA), but these still need to meet certain requirements.

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An LRBA involves an SMSF trustee taking out a loan from a lender and purchasing a single acquirable asset (or collection of identical assets with the same market value) with those funds. The asset must be held in a separate bare trust and any investment returns earned from the asset accrue to the SMSF. In a case of default on the loan, the lender’s rights are limited to the asset held in the separate trust i.e. there is no recourse for the lender to pursue other assets in the SMSF. An LRBA is also sometimes referred to as a non-recourse loan.

Just like any investment you make within your SMSF, any asset you purchase via a loan needs to be for the sole purpose of providing a retirement benefit to the SMSF members. It is part of the investment strategy, which states how that investment will benefit the overall outcome of the fund.

The investment strategy should explain how the loan will be serviced. If, for example, the SMSF needs to pay a pension in the future, the investment strategy will outline how it will be paid while servicing the loan or whether the asset will be sold.

An investment strategy would also need to explain why a fund had allocated a significant portion of its funds to an illiquid asset if it had very few other investments.

Borrowing and investing in property both need to be allowed in the SMSF’s trust deed.

How does SMSF borrowing work?

Once an SMSF trustee has identified a single acquirable asset it wishes to purchase, it can choose to take out a loan from a commercial provider (some banks and mortgage providers have loans specifically tailored for SMSFs). Or, in some circumstances, it can borrow from a related party or a non-bank lender as long as the arrangement is on an arm’s-length basis (see below).

Expenses incurred in connection with borrowing and acquiring the asset, such as loan establishment fees and stamp duty, can be paid for from LRBA borrowed money.

A bare trust must be set up to hold the asset and SMSF trustees must make sure the asset is transferred directly to the trust. If, even temporarily, an SMSF trustee obtains title to the asset they will contravene the Superannuation Industry (Supervision) Act 1993.

Some lenders require insurance to be taken out over the asset being purchased via a loan, and the SMSF needs to make sure it has sufficient funds to pay these insurance premiums.

Single acquirable asset

A lot hinges on the definition of a ‘single acquirable asset’ and the ATO has issued a ruling (SMSFR 2012/1) that further clarifies this definition.  

That ruling states:


An asset is defined in subsection 10(1) to mean any form of property. In the context of an LRBA, an acquirable asset is therefore any form of property, other than money, that a trustee of an SMSF is not otherwise prohibited from acquiring.


This ‘single acquirable asset’ definition means that a separate LRBA is required for each individual property title. But SMSFR 2012/1 also assists with some definitions around common questions and misconceptions.

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For example, SMSF ABC wants to acquire two blocks of land next to each other, with two separate titles, which the owner will only sell as a parcel. However, there is no impediment to the two blocks of land being sold separately at some point in the future. In this case the two blocks of land are not a single acquirable asset and would need to be acquired under two separate LRBAs.

However, if there is an entity that unifies a number of separate titles of land then that can sometimes make adjoining land, and what is on it, a single acquirable asset.

For example, if there was a factory constructed across three titles, that factory adds considerable value to the land and is a relevant ‘unifying physical object’, which makes the factory and the land across those three titles a single acquirable asset that could be acquired under a single LRBA. However, if the factory were derelict, and therefore not adding value to the land, this would not be the case.

The principle of a ‘unifying physical object’ is particularly important when it comes to farms. Even if unifying agricultural activities are being carried out across a number of land titles, unless there is a unifying physical object – such as a piggery across the titles – each land title needs a separate LRBA.

Repair or maintenance versus improvement

SMSFR 2012/1 also provides guidance around what the ATO considers repair or maintenance versus what it considers improvement. The difference for the SMSF is that it can use monies borrowed under an LRBA structure for repairs or maintenance of an asset, but not improvements. However other funds, such as accumulated funds held by the SMSF, can be used to fund improvement as long as the asset does not become a different asset.

There have been many questions to the ATO over the years about the difference between repair and maintenance and improvements, which prompted SMSFR 2012/1. As per the ruling, maintain and repair are defined as follows:


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Maintain, when used as a transitive verb is defined to mean (among other things) ‘to keep in existence or continuance; preserve’; ‘to keep in due condition, operation, or force; keep unimpaired’; and ‘to keep in a specified state, position’. Thus, maintaining an asset typically involves work done to prevent or anticipate defects, damage or deterioration (in a mechanical or physical sense). For example, repainting a timber house to prevent deterioration is typically maintenance.

A repair ordinarily means the remedying or making good of defects in, damage to, or deterioration of property to be repaired (being defects, damage or deterioration in a mechanical and physical sense) and contemplates the continued existence of the property.


An improvement is defined as follows:


Improve, when used as a transitive verb, is defined to mean (among other things), ‘to bring into a more desirable or excellent condition’; and ‘to make (land) more profitable or valuable by enclosure, cultivation, etc.; increase the value of (property) by betterments, as buildings’.

To determine if an acquirable asset has been improved it is relevant to consider if the state or function of the acquirable asset as a whole has been significantly altered for the better compared to when it was acquired under the LRBA. Substantial alterations or the addition of further substantial features or rights to the acquirable asset for the better will result in an improvement to the acquirable asset. However, alterations or additions that are relatively minor or trifling when compared to the acquirable asset as a whole will not result in an improvement to the acquirable asset.


The ATO uses the example of a cyclone, which damages the roof of a house in an LRBA structure. The ATO says that replacement of the entire roof with the modern equivalent is a repair as it is restoring the asset to what it was. If ‘superior materials’ are used it is a ‘question of degree’ as to whether the changes significantly improve the state or function of the asset as a whole.

However, if a second story was added to the house at the time of replacing the roof, that would be considered an improvement.

Even when making improvements SMSF trustees must make sure they do not change the nature of an asset – for example refitting a residential property into a commercial hairdressing salon.

If the character of an asset has fundamentally changed the trustee of the SMSF will contravene subsection 67A of the Superannuation Industry (Supervision) Act 1993, which allows limited recourse borrowing arrangements.

An LRBA from a related party

Although the rules were tightened in 2016, you can still borrow to purchase an asset via an LRBA from a related party as per the ATO definition:


A ‘related party’ of your fund includes:

  • The relatives of each member
  • The business partners of each member
  • Any spouse or child of those business partners
  • Any company the member or their associates control or influence
  • Any trust the member or their associates control

Employers who contribute to your superannuation and associates of employers who do so (business partners, companies or trusts the employer controls, and companies and trusts that control the employer) may also be related parties.

The ATO issued a compliance guideline to help SMSFs understand arm’s-length terms for LRBAs – Practical Compliance Guidelines (PCG) 2016/5 – Income tax arm’s-length terms for limited recourse borrowing arrangements established by self-managed superannuation funds.

If an LRBA is not set up on an arm’s-length basis the SMSF may be required to pay non-arm’s-length income tax, or NALI, which means the income is taxed at 45 per cent instead of 15 per cent.

PCG 2016/5 explains the ‘safe harbour’ terms on which SMSF trustees can structure their LRBAs on an arm’s-length basis.

Those terms specify the interest rate the loan must be set at, which is the Reserve Bank of Australia Indicator Lending Rates for banks providing standard variable housing loans for investors published for May, immediately prior to the start of the relevant financial year. The ‘safe harbour’ terms also dictate that the rate can be fixed or variable, the terms of the loan, the loan to market value ratio (a maximum 70 per cent for both commercial and residential property), the security and nature (both principal and interest) and frequency of repayments.

Even if an LRBA does not meet all the ‘safe harbour’ terms it does not necessarily mean that the arrangement is not on an arm’s-length basis, just that the trustees would have to prove to the ATO how it was an arm’s-length transaction.

Intermediary LRBA update

A new legislative instrument registered in May 2020 has made it easier for SMSFs to acquire property via a limited recourse borrowing arrangement using a holding trust. This could be a slightly easier way for some SMSF trustees to add a real property asset to their fund.

Previously, according to Graeme Colley, executive manager, SMSF Technical & Private Wealth at SuperConcepts, the fund acted as an interposed entity for purposes of the LRBA, so the use of the intermediary just cuts out one step in the transaction.

An intermediary LRBA refers to an arrangement that involves the SMSF, a holding trust and a lender whereby the SMSF borrows funds for an asset indirectly through the holding trustee (which is a member of the SMSF). The trustee of the holding trust borrows the money from a lender but the SMSF maintains the holding trusts borrowing. The new legislation excludes the SMSF’s investment in the holding trust from being an in-house asset, as per the description above, but the intermediary LRBA has to meet the below requirements as outlined in SPR 2020/1: Superannuation Industry (Supervision) In-house Asset Determination – Intermediary Limited Recourse Borrowing Arrangement Determination 2020.


The Intermediary LRBA is an arrangement entered into by the parties that meets the following requirements:

(1) a holding trust is established with members of a fund being the only trustees or shareholders and directors of the corporate trustee (Holding Trustee)
(2) the trustee of the fund is a beneficiary of the holding trust
(3) the Holding Trustee holds an acquirable asset (Asset) on trust for the trustee of the fund, who is beneficially entitled to the Asset
(4) the Asset is a single acquirable asset (as referred to in subsection 67A(1)) that the trustee of the fund is allowed to acquire under the Superannuation Industry (Supervision) Act 1993
(5) the Holding Trustee enters into a borrowing as principal with a lender with the borrowing secured by a mortgage over the Asset
(6) the contract or deed of borrowing, referred to in paragraph (5), between the Holding Trustee and the lender may not limit the lenders right of recourse, under the contract or deed, to only the Asset in the event of default
(7) the lender may require that personal guarantees are given as part of the Intermediary LRBA
(8) the arrangement is established by a legally binding deed(s) under which the trustee of the fund and the Holding trustee agree, for:

(i) the trustee of the fund to maintain all borrowing obligations entered into by the Holding Trustee with respect to the borrowing referred to in paragraph (5)
(ii) the trustee of the fund is absolutely entitled to any income derived from the Asset, less fees, costs, charges and expenses incidental to the acquisition, holding or management of the Asset
(iii) the trustee of the fund has the right to acquire the legal title of the Asset on completion of the borrowing referred to in paragraph (5)
(iv) the rights of the Holding Trustee or any Guarantors against the trustee of the fund in connection with default on the borrowing referred to in paragraph (5) is limited to the Asset.

(9) the documentation referred to in paragraph (8) in connection to the borrowing referred to in paragraph (5), is disclosed to the lender at the time of the borrowing.


The legislation has been backdated to apply to intermediary LRBAs established from 24 September 2007 and any established in the future.

Other investments

You can use an LRBA structure to purchase shares. However, those shares need to be considered a single acquirable asset. A collection of shares in a single company that are identical, have the same market value and are bought together at the same time would be considered a single acquirable asset and could be purchased under one LRBA arrangement. But different LRBAs are required for shares from different companies bought at different times.

Shares issued under a dividend reinvestment plan for the parcel of shares acquired under one LRBA cannot be retained in the arrangement. They cannot be added to the parcel, as that is not considered a replacement asset. The shares would have to be transferred out of the LRBA arrangement.

An LRBA can also be used to invest in exchange-traded options over shares, however if the option were to be exercised (i.e. converted to shares) or sold, it would change the nature of the asset. Therefore the LRBA over the exchange-traded options needs to be brought to an end before the exercise date of the option.

Refinancing

The ATO says that refinancing of an LRBA is allowed where the new borrowing is solely to extinguish the previous loan. A new LRBA structure is required to be entered into with the same requirements for the LRBA to be over a single acquirable asset.

A scenario where this would not be the case would be if the refinanced LRBA was for a higher amount and the additional funds were used to purchase an additional income-producing asset.

Also the SMSF trustees need to make sure the legal ownership of the asset is not temporarily acquired by the SMSF trustee when changing to the new arrangement.

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Learn more about SMSF investment in the following SuperGuide articles:

The importance of asset allocation

February 10, 2021

SMSF investment rules: Collectables and personal use assets

October 15, 2020

How to create an SMSF investment strategy (including example documents)

August 6, 2020

How to achieve genuine diversification in an SMSF

August 3, 2020

How do SMSF retirees invest?

March 14, 2020

10 steps to buying a commercial property and leasing it to your SMSF

February 12, 2020

What on earth is an in-specie transfer?

January 15, 2020

How to invest in infrastructure through an SMSF

October 1, 2019

ETFs: How do I use them and what do they cost?

June 19, 2019

SMSF guide to hedging

May 1, 2019

SMSFs and property: A Super Guide

April 5, 2019

The definitive SMSF guide to franked dividends

April 2, 2019

SMSF investment rules: What every trustee should know

February 15, 2019

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