Find out how a limited recourse borrowing arrangement lets you use property to fund your retirement.
Find out how a limited recourse borrowing arrangement lets you use property to fund your retirement.If you’ve chosen a self-managed super fund (SMSF), odds are you’ve heard the term “limited recourse borrowing arrangement”. These arrangements are often used to source loans through an SMSF. However, what is a limited recourse borrowing arrangement, and should you seek one out?
What is a limited recourse borrowing arrangement?
A limited recourse borrowing arrangement, or LRBA, is a loan sourced by an SMSF trustee. The SMSF trustee uses these funds to purchase a single asset to invest in to be held in a separate trust. Returns on the investment go back to the SMSF trustee.
An LRBA is “limited recourse” because of the different way defaults are treated. Traditional or full recourse loans mean that the lender can go after a borrower’s personal assets in the case of default.
For instance, if you default on a home loan, your lender can foreclose on and sell your house to recover the debt. In the event that the sale of your house doesn’t cover the outstanding debt, you will still be obligated to pay the shortfall.
By contrast, in an LRBA the lender’s rights are limited to reclaiming the asset that the loan funds originally purchased, which is held in separate trust. The lender has no recourse to any other assets held in the SMSF.
How does an LRBA relate to self-managed super funds?
Limited recourse borrowing arrangements are used by SMSFs to take out loans to purchase assets. The assets purchased by LRBAs are typically residential or commercial property.
In order to invest in property, most SMSFs will require a home loan. Home loans to SMSFs are set up as limited recourse borrowing arrangements.
The benefit of a limited recourse borrowing arrangement is that the other assets in your SMSF will be protected. If your SMSF defaults on its property loan, the lender will be able to foreclose on the property, but will not be able to touch any of the other assets in your SMSF.
Should I invest in property through my SMSF?
Property investment is an increasingly popular strategy for SMSFs. In September 2013, limited recourse borrowing arrangements accounted for $9.167 billion in SMSF fund allocation. By September 2017, this figure had skyrocketed to $30.73 billion.
Assets invested in LRBAs (Billions)
Source: Australian Taxation Office
The primary benefit of investing in property through your SMSF is that it helps diversify your portfolio. There are also tax benefits to owning property through an SMSF. For instance, super funds are taxed at 15%, which is a lower rate than personal tax rates.
Also, there are capital gains tax concessions for property investment through SMSFs. If the property is sold during the SMSF’s accumulation phase, CGT is discounted. If it’s sold during the SMSF’s pension phase, it’s exempt from CGT.
If you’re a business owner and use your SMSF to buy a commercial property, you can use the property as your business premises. However, you must lease the property at commercially competitive rates.
Before investing, however, you should weigh up the potential risks versus the benefits. Property investment can be lucrative, but like any investment, there’s no guarantee of return.
Also, setting up an SMSF trust to buy property can be a costly exercise. You’ll need to ensure that the fees and charges associated with setting up your LRBA don’t outweigh its potential benefits.
Finally, SMSF home loans usually carry higher interest rates than traditional home loans. You’ll need to make sure your SMSF can afford to make loan repayments and can continue to do so should rates rise.
How do I use an LRBA to buy property through my SMSF?
Buying property through an SMSF requires a fairly complex structure and you’ll likely need an accountant or financial planner to set it up for you. However, once this structure is set up, you'll apply for a limited recourse SMSF home loan much like you would apply for any other home loan.
First, your accountant will set up what’s known as a bare trust. This is a trust separate to the other assets of the SMSF.
Next, you will decide on a trustee to act as custodian for the property. Some lenders require the trustee to be a company.
Next you will apply for an SMSF home loan. Your trustee will pay the deposit on the property you’ve selected on your behalf, and will put the property up as security for the SMSF home loan. You will be required to cover any stamp duty costs and legal expenses through your SMSF.
After your SMSF loan settles, you will make repayments on the loan and cover any expenses related to maintaining the property.
While the application process for an SMSF home loan may be similar to standard home loans, you will require some specific documents. These can sometimes take a bit of time to source, which means approval times for SMSF home loans can be longer than for traditional home loans.
Some of the documents you’ll require are:
- SMSF establishment deed or deed update. This is the document establishing your self-managed super fund. If the original deed did not allow borrowing through your SMSF, you’ll need an updated deed showing that your SMSF is allowed to borrow, to appoint custodians and to invest in property.
- Trustee for SMSF. Some lenders require that the trustee of your SMSF is a company.
- Evidence of bare trust. Your SMSF will need to establish a bare trust in which to hold the property, and your lender will need all the documents showing the establishment of this bare trust.
- Bare trust trustee. Some lenders require that the trustee or custodian for the bare trust must be a company.
- SMSF investment strategy. You’ll need to provide documents showing your SMSF’s investment strategy, and that property investment forms part of this strategy.
- Limited Statement of Advice. Some lenders may ask for a Limited Statement of Advice, which is a document outlining the recommendations made by a financial adviser pertaining to your SMSF.
To learn in detail about buying a property through an SMSF, check out our guide.
Investing in property through your SMSF can be a savvy diversification strategy. If your SMSF doesn’t have the cash on hand to buy a property outright, a limited recourse borrowing arrangement through an SMSF home loan could be the answer.
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