A few of our clients have been asking recently about recourse borrowing arrangements, in particular, how they work and what the benefits and drawbacks of using them are. We’ve gathered together some information to help navigate through this potentially tricky area.
What is a SMSF Limited Recourse Borrowing Arrangement?
A SMSF limited recourse borrowing arrangement typically involves a SMSF taking out a loan from a third party lender or from a related party, such as a member of the fund. The SMSF then uses the loan, together with its own available funds, to purchase a single asset (normally a residential or commercial property) that is held in a separate trust.
This type of arrangement can assist members to grow their retirement savings but there are many risks and issues that should be considered before embarking on this type of strategy.
What are the key benefits?
- Leverage your superannuation savings – borrowing to invest allows a fund to acquire a beneficiary interest in an asset that the fund may not otherwise be able to afford
- Tax concessions – if a fund is in the accumulation phase then the income received from an asset purchased with limited recourse borrowing arrangement will be not be taxed over 15%
- Asset Protection – as superannuation assets are protected against creditors in the event of bankruptcy then this protection extends to any assets that the super fund as acquired beneficial interests in
What are the key risks?
- Only certain assets can be acquired – this typically means that borrowings can’t be used to purchase assets that the trustee or related party currently owns, however, some exceptions do apply to business premises and listed securities
- Property alterations and funding improvement costs – assets acquired with limited recourse borrowings can’t be altered if it fundamentally changes the character of that asset
- Cost – there will likely be additional costs in the setup
- Liquidity – loan repayments are deducted from the fund so careful planning will be needed to ensure there is enough liquidity to meet the funding obligations as they fall due
- Loan documentation and purchase contract – if the borrowing arrangement isn’t structured correctly then the ATO may require that the arrangement stops and the property is sold, potentially causing a substantial loss to the fund
- Tax losses and capital gains – any tax losses that arise are quarantined in the fund and can’t be used to offset taxable income derived outside the fund
- Governing rules and other matters – borrowings must be in line with the investment strategy of the fund and the governing rules of the SMSF need to allow for borrowings
- Rules around zero interest recourse borrowing arrangements likely to change – the ATO are currently reviewing loans from members to funds and in particular whether the interest paid is commercial.
Want more information?
We’ve compiled a fact sheet on SMSF Limited Recourse Borrowing Arrangements to provide you with more in-depth information. Download it here
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