While purchasing property through SMSF lending is becoming increasingly popular, the requirements and restrictions around the borrowing strategy can be quite stringent.
SMSF lending for property investment can become complicated due to the strict borrowing conditions known as a limited recourse borrowing arrangement (LRBA). Borrowing from your superannuation can allow for greater SMSF portfolio diversification but consequently does carry some risks that should be considered when deciding between financing options.
The Tax Office has highlighted concerns with related party loans in SMSF borrowing arrangements (LRBAs), mainly whether they are made on commercial terms.
All loans to SMSFs must be on arm’s length terms. An arm’s length transaction is designed to ensure that both parties in the deal are acting in their own self-interest and are not subject to any pressure or duress from the other party.
However, the ATO has recently stated that LRBAs that involve a related party must be on commercial terms for the entire 2015/16 financial year by 1 July 2016.
Putting a loan on commercial terms requires the arrangement to align with what an arm’s length financier would require, including:
- a written document including the same sort of terms
- requirements for interest and principal repayments
- a comparable loan to value ratio to that required by banks for LBRAs
- adequate security (including registering a mortgage and taking guarantees)
To remain compliant, SMSF trustees involved in LRBAs should take steps now to ensure their LRBAs are recorded with commercial terms and have operated from at least 1 July 2015 on those terms.