In the opening article of this three-part series, we examined the fundamentals of limited recourse borrowing arrangements (LRBAs) available to SMSFs for investment in residential or commercial properties. This installment will delve into the specifics of the process, with a focus on New South Wales (NSW), where the rules vary slightly from state to state.
Integrating real estate investment with self-managed superannuation funds can be a strategic move, though it requires adherence to critical regulations. The intricacies of borrowing present a challenge, yet they can be distilled into practical steps. Although the process is complex, we will demonstrate the functioning of Limited Recourse Borrowing Arrangements (LRBAs) this week.
As mentioned previously, integrating real estate investments into Self-Managed Super Funds (SMSFs) need not be an overwhelming challenge, yet it demands meticulous preparation. Crucially, you or your advisors should have a thorough understanding of the prevailing borrowing exception stipulated in Section 67A of the Superannuation Industry Supervision (SIS) Act. Borrowing within an SMSF is more precisely described as a Limited Recourse Borrowing Arrangement (LRBA). In this session, we will delve deeper into LRBAs and delineate the standard procedures entailed.
To summarize, Section 67A specifies the criteria for a Limited Recourse Borrowing Arrangement (LRBA). To qualify for this exception, the borrowing must adhere to the prescribed regulations.
The borrowed funds must be used to acquire a “single acquirable asset.”
The asset must be held in trust by another trustee, known as a “bare trustee,” “custodian trustee,” or “holding trustee,” so that the SMSF trustee acquires a beneficial interest.
The SMSF trustee must have the right to acquire legal ownership of the asset by making one or more payments.
The lender’s rights, or those of any other person, in the event of default must be limited to the acquirable asset only (this is the limited recourse arrangement) and not extend to any other SMSF assets.
The asset must be one that the SMSF is permitted to purchase and own, regardless of whether it borrowed to buy it.
If you believe the property and strategy suit your needs and decide to proceed, here are the typical steps involved in borrowing by an SMSF:
Gather Information: either you or your adviser should collect data on your superannuation balances, contributions over the last three years, and predicted future contributions.
Seek Loan Pre-Approval: Provide this information to a mortgage broker or bank to determine if you qualify for a loan and to get an indication of your borrowing limit and maximum loan-to-value ratio (LVR). Do this before incurring other costs to avoid wasting money.
Check Trust Deed: Ensure the SMSF trust deed allows the trustee to borrow, grant a mortgage, and hold an asset through a custodian/holding/bare trustee. Amend the deed if necessary.
Amend Investment Strategy: Update your SMSF investment strategy to include the property investment and borrowing, considering investment risks and strategies to minimize them, such as insurance, higher deposits, and extra contributions.
Establish Corporate Trustee: Set up a corporate trustee for the holding trust, separate from the SMSF. Avoid using individual trustees to expand your lender options and reduce litigation risks.
Prepare Holding Trust Documentation: Have your advisors obtain or prepare the holding trust documentation. It’s advisable to use a reputable legal firm that provides upfront quotes and clear service outlines.
Source Property: Find a suitable property and begin negotiations while submitting details to the lender for valuation and borrowing facility confirmation.
Document Trustee Resolution: Ensure the custodian/holding/bare trustee resolves in writing to act as the holding trustee of the asset for the SMSF trustee.
Negotiate and Exchange Contracts: Finalize the price and exchange contracts with the vendor. Avoid using personal funds for any part of the deposit to prevent double stamp duty. The purchaser on the contract should be the company trustee of the custodian/holding/bare trust, not the SMSF trustee.
Note that each state has its own naming conventions.
State | SMSF (No Borrowings) | Bare Trust (Borrowings) |
NSW | SMSF Trustee Pty Ltd ACN XXX XXX XXX as trustee for Name of Fund | Holding Trustee Pty Ltd ACN XXX XXX XXX |
VIC | SMSF Trustee Pty Ltd ACN XXX XXX XXX as trustee for Name of Fund | Holding Trustee Pty Ltd ACN XXX XXX XXX |
QLD | SMSF Trustee Pty Ltd ACN XXX XXX XXX as trustee for Name of Fund | Holding Trustee Pty Ltd ACN XXX XXX XXX |
SA | SMSF Trustee Pty Ltd ACN XXX XXX XXX as trustee for Name of Fund | Holding Trustee Pty Ltd ACN XXX XXX XXX |
TAS | SMSF Trustee Pty Ltd ACN XXX XXX XXX as trustee for Name of Fund | Holding Trustee Pty Ltd ACN XXX XXX XXX |
WA | SMSF Trustee Pty Ltd ACN XXX XXX XXX as trustee for Name of Fund | Holding Trustee Pty Ltd ACN XXX XXX XXX for SMSF Trustee Pty Ltd ACN XXX XXX XXX |
ACT | SMSF Trustee Pty Ltd ACN XXX XXX XXX as trustee for Name of Fund | Holding Trustee Pty Ltd ACN XXX XXX XXX |
NT | SMSF Trustee Pty Ltd ACN XXX XXX XXX as trustee for Name of Fund | Holding Trustee Pty Ltd ACN XXX XXX XXX as trustee for Name of Holding Trust as bare trustee for SMSF Trustee Pty Ltd ACN XXX XXX XXX as trustee for Name of Fund ABN XX XXX XXX XXX |
Complete the borrowing arrangements: and agree on terms with your lender.
Refer to your documentation: kit and prepare the necessary documents for the custodian/holding/bare trustee and the SMSF trustee to sign the trust deed of the holding trust.
The SMSF trustee (who is the borrower) should now sign the loan and mortgage documents with the lender
Ensure all payments related to settling the purchase are made either directly from the SMSF trustee’s bank account or from the lending facility as part of the settlement.
Submit the holding trust deed, along with statements showing payments for the deposit and settlement, to the stamp duty authority in most states (excluding Queensland) for stamp duty payment.
Arrange the tenancy with the lease in the name of the holding trust trustee.
All rental income should now be paid into the bank account of the SMSF trustee. It is not recommended for the holding trustee to apply for a tax file number or open a bank account.
The SMSF trustee should arrange for loan payments to be made to the lender as per the loan schedule. A useful Loan Amortisation Spreadsheet can be found here.
Register the SMSF trustee for land tax if applicable.
Register the fund for GST if deemed necessary by your tax agent.
When the loan is eventually repaid, transfer the asset from the holding trustee to the SMSF trustee. Only nominal stamp duty should apply, provided the holding trust deed was previously stamped and the holding trust is a bare trust.
While not necessarily easy, simplifying the process into manageable steps can make it seem more straightforward. This article is intended to be an educational resource rather than a directive manual. Always consult with a reputable and licensed professional before undertaking the steps outlined above, no matter your location or situation.
In conclusion, each purchase will differ, particularly as regulations change from state to state. It is advisable to consult with a seasoned SMSF expert before applying this strategy to your fund. Soon, we'll outline the most frequent mistakes SMSF trustees make when purchasing property and the resulting repercussions.
NEXT STEP: THE 20 MOST COMMON MISTAKES (ensure you read this to avoid common pitfalls).
As always, feel free to reach out if you wish to discuss your options. You can schedule an appointment by clicking here.
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