A limited recourse borrowing arrangement requires an SMSF trustee to take out a loan from a third party lender. The trustee then uses those funds to purchase a single asset (or collection of identical assets that have the same market value) to be held in a separate trust. If the loan defaults, the lender’s rights are limited to the asset held in the separate trust. This means there is no recourse to the other assets held in the SMSF.
So who can lend to an SMSF under a limited recourse borrowing arrangement?
The fund can borrow from a bank or other financial institution or from a related party. It is very important that the right documentation is in place and that everything has been done correctly.
What documents do we need and what are the common mistakes?
First you will need a Bare Trust (sometimes referred to a Custodian Trust or Holding Trust). The Bare Trust will also need a trustee. Usually this is a corporate trustee.
You will need to complete the offer and acceptance correctly to ensure the property is purchased by the right entity. Each state is different so it is very important to get this right. If it is completed incorrectly there may be stamp duty implications to correct the error.
It is very important that a loan agreement is in place. If you are lending from a bank this will be prepared by them but if you are lending from a related party (such as a member) you will need to arrange for the preparation.
Be mindful of the Safe Harbour Provisions when preparing the loan agreement. The below guidelines outline what terms, interest rates and loan to market value ratio (LVR) should be used: https://www.ato.gov.au/law/view.htm?DocID=COG/PCG20165/NAT/ATO/00001
Once this has all been done you will then need to register the mortgage over the property. Again, if you are borrowing from a bank they will do this directly but if you are borrowing from a related party you will need to do this yourself.
Here is an example of a property purchase using a limited recourse borrowing arrangement:
Jeffrey is a member if the Prosperity Self-Managed Super Fund and has his eye on a property in WA that he thinks will be a great investment. He does his research and obtains a Statement of Advice from his financial advisor to ensure this is the right strategy for him and his fund.
Jeffrey sets up the “Prosperity Bare Trust” with a corporate trustee. He intends to borrow from himself personally. The property is $430,000 and his super fund has $200,000 available. The fund has additional cash that will be used to pay for the stamp duty and other purchasing costs. He will therefore need to borrow $230,000.
After determining the correct name to include as the buyer Jeffrey puts an offer on the property. He is very happy when the offer is accepted and engages a lawyer to prepare the loan agreement between himself and his super fund.
Jeffrey uses the Safe Harbour Provisions to determine the terms and interest rate and ensures the loan does not exceed 70% of the property value. At settlement the super fund pays $200,000 plus purchasing costs to the seller and he transfers the balance from his personal bank account. His lawyer then registers a mortgage over the property.
Jeffrey has done very well to ensure that he has complied with the LRBA rules and engaged the appropriate people to assist including the preparation of the Statement of Advice to confirm this strategy is suitable for both himself and his super fund.
Check out our other blog regarding related party borrowing here.
If you want to discuss your options surrounding a limited recourse borrowing arrangement contact us now!
This information has been prepared without taking into account your objectives, financial situation or needs. Because of this, you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation or needs.