'Ding-Dong the Witch Is Dead': Development of property in an SMSF with an LRBA after the 2019 Federal Election
In our June newsletter, we considered potential superannuation compliance issues of using an SMSF to develop a property without any limited recourse borrowing arrangement (“LRBA”) in place. Now that the threat to limited recourse borrowing posed by the Labor opposition has passed Jeff Song looks at what SMSFs can now do in property development using an LRBA.
John and Mary are considering purchasing a property in their SMSF by borrowing money under an LRBA. They are quite savvy property investors and found a commercial property at a sought-after location that has a good potential for earning high rental income for its price.
While generally well maintained, the property would need some renovation and refurbishment work done before renting out in order to generate the level of income they expect. They see this as a great investment for their SMSF and wish to utilise the tax concessions available to SMSF investments but are concerned whether to do this would be in breach of the superannuation laws.
In a nutshell, it is possible (subject to conditions of course) to renovate and/or refurbish the property but extensive work or development resulting in change in fundamental nature of the property is prohibited.
If the work is merely repair or maintenance work (and not an improvement to the property) it is possible to use the money borrowed under the LRBA.
Renovation and refurbishment are likely to be seen as an improvement of the property and must be funded by sources other than the money borrowed under LRBA (eg. from the accumulation balance in the fund).
The extent of the work must not result in fundamental change in the nature of the property. While there is no universal rule of thumb here, examples of fundamental change provided by ATO include subdividing land, building on vacant land, knock down and rebuild, and converting residential property to a commercial property.
Before committing to the investment or at least before undertaking any major work on the property, seek advice as to whether your renovation plan would result in fundamental change in nature of the property and breach superannuation laws.
The Trustee of the fund should be prepared for the fund audit and ensure they are able to clearly show the nature of the work (whether repair/maintenance or improvement) and also the source of money used for the work.
Finally, the Trustee needs to ensure compliance with the sole purpose test, investment strategy, trust deed and risk management requirements associated with engaging related parties. For further details about these issues please refer to our June article and contact Townsends Business & Corporate Lawyers on (02) 8296 6222 or email firstname.lastname@example.org to see how we can assist.