Since the rules around using an SMSF to purchase property were relaxed, first in 2007 and with further amendments in 2010, thousands of SMSF trustees used this as an opportunity to invest in both residential and commercial property. However, loans were restricted to a limited recourse borrowing arrangement or LRBA and this practice continued for a decade.
Two issues arose in that time, and the first was concern by the Reserve Bank of Australia about the number of SMSFs going into significant debt to acquire property. The second came from the ATO (Australian Taxation Office) and the possibility that some taxpayers were dodging superannuation caps. By using LRBAs, they could place extra money into their super funds where they would be taxed at concessional rates.
As a result, the ATO issued new guidelines to SMSFs choosing to use related-party loans rather than bank finance to purchase property. Trustees had until 31 January 2017 to review their fund arrangements and it is possible that some trustees have not yet made the necessary arrangements to ensure compliance with the new rules.
Trustees must understand that any loan terms they have accepted to buy property must be “an arms-length commercial arrangement”. In some cases, LRBAs have been established with related-party lenders on terms that would not typically be accepted as a commercial arrangement. Usually these terms are more generous than bank finance with lower interest rates, excessively long loan terms and no requirement to make regular payments.
While this may seem a good deal at the time, it puts at risk the overriding purpose of establishing an SMSF, which is to provide retirement income for the fund members. There are key issues with some LRBAs that put this purpose at risk such as:
- The possibility that there will be insufficient income and contributions into the SMSF to service the loan;
- How the members would pay out the loan when they have retired and are no longer making contributions to the fund; and
- Whether the property or properties will be sufficiently liquid or earning enough income to pay pensions to members in retirement.
SMSF trustees who did not use bank finance for their property purchases and who have not sought information about the new rules themselves or by consulting SMSF service providers such as SMSF Assure should act immediately. It could be that they need to wind up the LRBA or refinance their loans on commercial terms, and notify the ATO that this has been done.
These are major changes to previously accepted loan arrangements that will have financial consequences for members if they are not addressed. The income from these properties can be taxed at the highest rate of 47% instead of the 15% concessional rate. If you are a fund trustee and have not addressed this issue yet, get professional advice on what steps to take, and act now.