In this guide
If you are an SMSF trustee who has borrowed money through your fund to acquire an asset, then you may be wondering what happens when that loan is paid off. And you are not alone.
Over 10% of all SMSFs have used a limited recourse borrowing arrangement (LRBA) at some stage, and many of these loans are now coming to an end.
Background to LRBAs
The limited recourse borrowing rules allow an SMSF to borrow money to purchase a ‘single acquirable asset’ that is held on trust for the SMSF.
The trustee of the holding trust is the legal owner of the asset and the SMSF trustee is the beneficial owner.
Once the loan has been repaid in full, the SMSF trustees have a right to acquire the legal ownership of the asset.
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Changes affecting LRBAs
Significant changes were made to the arm’s-length borrowing rules relevant for SMSF loans in 2016, including the introduction of a maximum term for the loan.
As a result of these changes, we are starting to see an increase in the number of these LRBAs coming to an end, with the SMSF having repaid the relevant loan.
When this occurs, SMSF trustees will need to consider what they can, or what they need to do once the loan is extinguished.
Does the ownership of the asset have to be transferred?
The LRBA rules do not compel the SMSF trustees to acquire the legal ownership of the asset once the loan has been repaid in full. The rules set out that the borrowing arrangement must “allow” this to occur at the end of the loan, but the rules do not specifically require it to take place.
In fact, the asset held on trust for the SMSF trustee can remain held that way well beyond the term of the loan that was used to acquire the asset, so long as all the relevant paperwork allows this.
However, trustees need to keep in mind the restrictions on making changes or improving the asset while the asset remains subject to a borrowing arrangement. No changes or improvements are allowed to the asset where it results in a fundamental change to the asset, or the use of the asset, while the asset remains held on trust for the SMSF.
For instance, if an LRBA was used to acquire a vacant block of land, then the SMSF can’t build a structure on that land as it would fundamentally change the asset.
The same would apply where an SMSF has borrowed to acquire a property that they would now like to subdivide. This would not be allowed while the asset remains held under a borrowing arrangement as the fundamental nature of the asset has changed, from a single title to multiple titles.
Where the loan is repaid and the asset is legally transferred into the SMSF trustees name, then all those restrictions are removed.
Options after the loan has been repaid
SMSF trustees would usually choose one of the following options once the SMSF limited recourse loan has been repaid:
1. Transfer the asset into the SMSF
Transferring the legal ownership of the asset to the SMSF trustee simplifies the overall property ownership. However, you will need professional legal assistance in the process as the title of the property needs to be legally changed using the relevant State or Territory based procedures.
If the arrangement was initially set up in accordance with those State or Territory based requirements, then the transfer should not trigger full stamp duty. Stamp duty concessions or exemptions should apply.
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Once the transfer has taken place, the ‘holding (bare) trust arrangement’ ends.
The SMSF trustees should check for any formal wind up or documentation requirement.
In all cases, the SMSF trustees should create a trustee minute that covers their decision to end the holding trust arrangement.
2. Arrange for the sale of the asset
If you are considering selling the asset that is held on trust for your SMSF in a relatively short period of time, you could consider leaving the asset held as is until that sale occurs.
This would eliminate the costs incurred in transferring the asset into the name of the SMSF trustee.
For the sale to take place, the SMSF trustees would usually need to give a written directive to the holding trust trustee to sell the asset.
Make sure you discuss this with your legal professional.
3. Leave the asset within the holding trust
The third option is to do nothing. The legal ownership of the asset remains as is, with the trustee of the holding trust, and the beneficial ownership of the asset remains with the SMSF trustee.
This option is often used when there may be some doubt or uncertainty around the initial establishment of the borrowing arrangement and if it was carried out in accordance with the requirements of the relevant jurisdiction.
If the correct establishment process was not carried out appropriately, then there may be full stamp duty levied on any transfer of the asset to the SMSF trustee.
Keep in mind the restrictions on making changes to the asset that will always apply while it remains held on trust, as mentioned earlier.
It is also worth noting that the in-house asset exemption that is given to these holding (bare) trust arrangements continues even after the loan has been repaid.
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