It is now some years since the Superannuation Industry (Supervision) Act was amended to permit SMSFs to borrow money to purchase assets including real estate. In recent years these arrangements have become popular and it is now quite common for SMSFs to enter into transactions involving borrowing to purchase real estate.
There are a number of requirements in order for the SMSF to be able to borrow. The basic structure in order to comply with the Legislation is as follows:
- Custodian or Bare Trustee – the property will be held by another Trust known as a Custodian. The Custodian will actually be the entity that purchases the property and will also be the Borrower.
- The SMSF must have the right to acquire legal ownership of the asset by making the required payments. So once the loan is fully repaid the asset would be transferred from the Custodian to the SMSF.
- Limited Recourse Loan – the loan that the SMSF obtains to purchase the property must be a Limited Recourse Loan. This means that the Lender’s rights in the event of default are limited to the asset purchased. The Lender then has no right to recoup any shortfall from the other assets of the SMSF. Because of the extra exposure a Lender has with a Limited Recourse Loan most Lenders will normally lend a smaller percentage of the purchase price than in a standard transaction. Most banks require the SMSF to contribute at least 30% of the valuation of property. The Limited Recourse Loan does not prohibit the Lender from taking a personal guarantee from Members, and most Lenders will require such a guarantee.
- Loan Repaid – once the loan is repaid the property is transferred to the SMSF.
- Sale of property – the Trustees of the SMSF are able to sell the property at any time.
A SMSF can borrow from either an external Lender or a related party such as a Member of the Fund. If a Member is loaning money to the SMSF the interest rate charged must be no more favourable to the Member than would be expected in an arm’s length transaction. There is no prohibition on a Member lending the SMSF money at less than market rates or even at zero interest.
The ability of a SMSF to borrow is not limited to purchase of real estate, and applies also to other assets such as shares. The Trustees of a SMSF should proceed with caution and ensure that the transaction is in the interests of the SMSF. There has been a big push by property spruikers to encourage SMSFs to buy property. Whilst there are legitimate benefits, Trustees should make sure they investigate the property being acquired carefully to ensure it offers a prospect of long term growth, and also consider the risks of short to medium term falls in value.
There are a range of compliance issues that arise. For example a SMSF cannot purchase a house from a Member. Whilst transactions where SMSFs borrow to acquire property have become common we strongly recommend that you obtain advice from both your Accountant and Lawyer before proceeding with borrowing by a SMSF to ensure that it is done in a way that complies with the Legislation.
