Limited recourse borrowing – how does it work?
A Limited Recourse Borrowing Arrangement (LRBA) is a commercial loan from either a related party of an SMSF or an unrelated financial institution that works to safeguard the assets of an SMSF.
When a trustee identifies a suitable asset to purchase on behalf of an SMSF, a private trust is established. The asset is then purchased using the borrowed funds and the private trust is recognised as the legal owner of the asset.
The Australian Taxation Office (ATO) has determined that an LRBA may only be used to purchase a “single acquirable asset” and trustees are urged to familiarise themselves with ATO restrictions prior to considering gearing in super. ATO ruling SMSFR 2012/1 contains a definition and examples of a single acquirable asset. See the Law section of the ATO website: www.ato.gov.au.
In an LRBA, the SMSF involved is identified as the legal beneficiary of the asset purchased with the loan. The SMSF is, therefore, responsible for all related transactions, which can include loan repayments and the receipt of investment income, as well as all taxation liabilities and benefits arising from the asset.
Borrowing under an LRBA ensures that if there is a default on the loan, the lender’s recourse is limited to the asset held by the private trust. All other assets held by the SMSF, including members’ benefits, are not at risk.
The most common asset purchased using an LRBA is property and, from time to time, repairs and maintenance on that property may be required. Borrowed funds may be used to repair or maintain the asset owned by the private trust, but the ATO places restrictions on alterations that significantly change or improve the value of the asset.
Ruling SMSFR 2012/1 states: “No amount that has been borrowed under an LRBA by a trustee of an SMSF may be applied to improve the single acquirable asset.”
Examples of actions that are considered repairs, maintenance or improvements can be obtained from the ATO website.
Once the LRBA is fully repaid, the SMSF has the right to take ownership of the asset.
Many trustees use an LRBA to purchase premises from which the SMSF’s members conduct their business. Although there are advantages to such an arrangement, gearing in super may not be a strategy suitable to all SMSFs.
If you are thinking about using an LRBA to purchase an asset for your SMSF, careful consideration should be given to the large amount of regulatory and legislative compliance required, along with the investment plans for the future of your SMSF.
As with all investment decisions, professional advice should be sought. If you would like further information please phone us on 02 9318 6400 or email fred.tortora@surrypartners.com.au.