29/08/2016

Acquiring a property through a SMSF using borrowed money may be an attractive investment choice for many, however, before the trustee/s get any ideas about carrying out renovations, building extensions and adding value to the property, it’s important to check whether the proposed renovations would comply with the law.

What does the law say about limited recourse borrowing arrangements?

•        Borrowed money can be used to acquire a ‘single acquirable asset’
•        Borrowed money can be used to maintain and repair the asset
•        Borrowed money cannot be used to improve the asset
•        Money from other sources can be used to improve, repair or maintain the asset
•        Any improvements allowed cannot result in the acquirable asset becoming a different asset.

What is the difference between ‘maintain’, ‘repair’ and ‘improve’?

The ATO’s SMSFR 2012/1 ruling (“ATO Ruling”) provides the following definitions:

‘Maintain’ essentially is any work done to prevent defects, damage or deterioration of an asset, provided that the work ensures the continued functioning of the asset in its present state.  This could be for example, painting the outside of the property.

‘Repair’ means remedying or making good defects in damage, to or deterioration of the asset and contemplates the continued existence of the asset.  An example of a repair may be fixing a broken window.

‘Improve’ means altering the asset significantly which improves the state or function of the asset.  Examples would include, building a garage, a swimming pool or extending a house to add another bedroom.

When does an ‘improvement’ result in the acquirable asset becoming a different asset?

The ATO Ruling contains details and examples of situations where an improvement would change the character of the asset.

For example the ruling states, if a residential house and land was purchased initially as the ‘acquirable asset’ and subsequently a two bedroom ‘granny flat’ was constructed in the backyard, because the character of the asset remains a residential premises then the addition of the ‘granny flat’ would be permitted as an improvement.

In comparison, if vacant land was purchased as the ‘acquirable asset’ and then a residential house was built on this vacant land, this would result in a different asset as the asset has changed from vacant land to a residential premises.  Such an improvement would not be permitted.

Whether or not an improvement to an asset is allowed under the rules is a question that depends on the particular circumstances and the nature of the changes to the asset that are to be made.

If in doubt, you can refer to the ATO’s ruling for guidance or alternatively, contact Townsends Business & Corporate Lawyers for a formal advice.

If improvements are made to the property that are not permitted, the trustee/s may be hit with an administrative penalty possibly as  much as $10,800 per trustee or be forced to wind up the arrangement earlier than planned.

All of the above issues could potentially be avoided once the limited recourse borrowing has come to an end with the loan being repaid and the asset transferred to the trustee/s of the Fund.  When the asset is held by the trustee/s of the Fund the property is no longer subject to the restrictions discussed above and the trustee/s can do any improvements they want!

For further information, please contact Townsends Business & Corporate Lawyers on (02) 8296 6222.