Common Mistakes Buying Property with Your SMSF

Purchasing property through your self-managed super fund can feel like a solid move if you have built up a decent balance and want control over where your retirement savings go.

The regulations changed recently, so if you are considering this option in Point Cook or anywhere else in Melbourne's west, you need to know what is still possible and what is not. Since August this year, new borrowing arrangements through your SMSF can only be used to acquire business real property, not residential. That does not mean residential property is off the table completely, but it does mean you cannot borrow to buy it anymore.

What Changed in August and Why It Matters

From 10 August this year, Limited Recourse Borrowing Arrangements entered into to purchase real property can only be used to acquire business real property. The legislation still allows SMSFs to borrow under an LRBA, but the type of property you can finance has been restricted. This applies whether you are borrowing from a bank, a non-bank lender, or a related party.

Your SMSF can still own residential property. You can hold an existing residential property, and you can buy one outright if your fund has the cash and the property meets all the usual rules. The property cannot be purchased from a related party, and no member or related party can live in it. If you exchanged a binding contract to buy residential property before 10 August, you are protected even if the settlement or loan occurs after that date. Refinancing an existing residential LRBA is also unaffected.

Consider a fund that has been leasing a warehouse in the Derrimut industrial precinct and wants to purchase the property. That arrangement can proceed under an LRBA because the warehouse is business real property. A fund wanting to buy a townhouse in Point Cook as an investment would need to pay cash, as borrowing for residential property is no longer allowed under the new rules.

How LRBAs Work and What Limited Recourse Means

An LRBA allows your SMSF to borrow money to acquire an asset, with the asset held in a separate holding trust until the loan is repaid. The SMSF holds a beneficial interest in the asset and receives the investment returns, such as rental income. Once the loan is repaid, legal ownership transfers to the SMSF. If the loan defaults, the lender's recourse is limited to the asset in the trust. No other assets in your SMSF are at risk.

The borrowed money must be used to acquire a single asset. You cannot buy multiple properties under one LRBA, even if they are similar. Loan establishment costs and stamp duty can be covered by the borrowed funds, but you cannot use the loan to improve an existing asset. The asset cannot be subject to any other charge apart from the one under the LRBA.

The holding trust must give your SMSF trustee a beneficial interest in the asset and the right to acquire legal ownership after making payments. A discretionary trust does not meet this requirement.

What Qualifies as Business Real Property

Business real property generally means land and buildings used wholly and exclusively in one or more businesses. The business does not need to be run by the entity holding the property. Whether a property qualifies depends on how it is actually used at the time of acquisition, not how it is zoned or marketed.

A warehouse leased to a logistics company qualifies. A shopfront leased to a retail tenant qualifies. An office leased to a professional services firm qualifies. A unit in a residential apartment building does not qualify, even if the tenant runs a home business from it.

Mixed-use properties require careful assessment. A property with both commercial and residential components may not qualify, or may only partially qualify, depending on the actual use. A concession exists for certain primary production property where a dwelling occupying no more than 2 hectares does not disrupt the test, provided the main use of the whole property is not domestic or private. That concession is specific to farming property and does not apply broadly to other mixed-use scenarios.

If you are looking at a property and unsure whether it meets the definition, speak to an SMSF specialist before proceeding. A property marketed as commercial does not automatically satisfy the legislative test.

Rental Income, Capital Gains, and Tax Treatment

Rental income earned by your SMSF is taxed at 15 percent during the accumulation phase. If the property is held for at least 12 months and then sold, a one-third capital gains tax discount may apply, which can produce a maximum effective rate of 10 percent on the discounted gain. The actual tax outcome depends on the property's cost base, selling costs, capital improvements, and your fund's overall position that year.

Capital losses can only be offset against capital gains, not against rental income. If your fund has a net capital loss in a year, it carries forward to offset future capital gains.

Once your fund is paying a retirement-phase pension, investment income from assets supporting that pension may be exempt under the exempt current pension income rules. If all of your fund's assets are supporting pensions at all times during the year, a capital gain on disposal is disregarded. If your fund has both accumulation and pension interests, the exemption is partial and depends on the method used and whether an actuarial certificate is required.

From 1 July this year, members with a total superannuation balance above $3 million face an additional 15 percent Division 296 tax on the proportion of earnings above that threshold. Members above $10 million face an additional 10 percent on the portion above that level. Division 296 tax applies to realised income and gains, not unrealised increases in property value. Rental income and realised capital gains may contribute to the calculation. LRBA amounts are disregarded when calculating your balance for Division 296 purposes.

Refinancing an Existing SMSF Property Loan

If you have a residential LRBA in place before 10 August, you can refinance it to another lender without being caught by the new rules. The ATO considers refinancing to mean entering into a new loan contract for the same asset, with the same or a new lender. The refinanced loan must relate to the same single asset, maintain the limited recourse character, and meet arm's length terms.

A significant change to the terms or conditions of an LRBA can end the arrangement and trigger a new one. Circumstances that may end an existing arrangement include refinancing that is inconsistent with the original arrangement, borrowing to acquire an asset not contemplated under the original arrangement, or changes to the ultimate beneficiaries. A new arrangement entered into after 10 August involving residential property cannot proceed.

If you are refinancing a residential investment loan or considering whether to move your SMSF property loan to another lender, confirm with your broker and SMSF adviser that the refinance will not be treated as a new arrangement.

Leasing Property to Your Business or a Related Party

Business real property can be leased between your SMSF and a related party without triggering the in-house asset rules, provided the lease is made on arm's length terms at market value. This allows your SMSF to own the premises your business operates from, with the business paying rent to the fund.

Consider a scenario where a member owns a plumbing business operating from leased premises in Laverton North. The SMSF purchases the commercial unit under an LRBA, and the business leases it from the fund at market rent. The rental income flows to the SMSF, and the business can claim the rent as a deduction. The arrangement must be documented properly, with a formal lease agreement and rent set at market rates.

This structure works only for business real property. Residential property cannot be leased to a member or any related party, regardless of the terms. The sole purpose test under section 62 of the SIS Act requires that your SMSF is maintained solely to provide retirement benefits. Any arrangement that gives members or related parties a present-day benefit may contravene that test.

Safe Harbour Rates and Arm's Length Terms

The ATO publishes safe harbour interest rates each year for SMSF LRBAs under Practical Compliance Guideline PCG 2016/5. These rates apply to both real property and listed securities. If your LRBA does not meet arm's length terms, income from the arrangement may be assessed as non-arm's length income and taxed at 45 percent.

This applies whether the loan is from a commercial lender or a related party. If a related party provides a personal guarantee to the lender, their recourse must be limited to the asset under the arrangement, not to any other SMSF assets.

Genuine offset accounts offered by an authorised deposit-taking institution are not treated as a borrowing or a charge over fund assets under existing ATO guidance.

Contribution Limits and Building Your SMSF Balance

The concessional contributions cap is $32,500 per year from 1 July this year. The non-concessional contributions cap is $130,000 per year. If you are planning to buy property outright without borrowing, you need sufficient funds in your SMSF, which means contributions, rollovers, or accumulated returns over time.

The bring-forward arrangement allows non-concessional contributions of up to $390,000 over three years if your total superannuation balance on 30 June of the previous year was below $1.84 million. Where your balance was between $1.84 million and $1.97 million, you can bring forward up to $260,000 over two years. Where your balance was between $1.97 million and $2.1 million, only the annual cap of $130,000 applies. If your balance equalled or exceeded $2.1 million, the non-concessional cap is nil.

If you are considering whether an SMSF loan or cash purchase makes sense for your situation, speak to a broker who works with SMSF clients regularly.

Property purchases through your SMSF are not suitable for everyone. The costs, compliance requirements, and liquidity implications are significant. The new restrictions on residential borrowing mean you need to be clear on your strategy before committing funds. If you are in Point Cook and exploring this option, call one of our team or book an appointment at a time that works for you.

Frequently Asked Questions