Understanding Limited Recourse Borrowing Arrangements (LRBA) in Self-Managed Super Funds (SMSFs)

Self-managed super funds (SMSFs) give individuals greater control over their retirement savings and offer flexibility in investment decisions. 

One popular strategy within SMSFs is using Limited Recourse Borrowing Arrangements (LRBAs) to invest in assets such as property. While LRBAs can be advantageous, they also come with regulatory requirements and risks that trustees must understand.

What is a Limited Recourse Borrowing Arrangement (LRBA)?

An LRBA is a borrowing strategy that allows an SMSF to acquire an asset using borrowed funds while limiting the lender’s recourse to the financed asset. In the event of a default, the lender can only claim against the asset purchased with the borrowed funds and not against the SMSF’s other assets.

Key features include:

• Separate Holding Trust: The asset purchased through an LRBA must be held in a separate bare trust until the loan is repaid.

• Single Acquirable Asset: LRBAs must be used to purchase a single asset or a group of identical assets with the same market value (e.g. a parcel of shares in the same company).

• Limited Lender Recourse: The lender can only claim the asset used as security in case of loan default, protecting the SMSF’s other investments.

• Compliance with Superannuation Law: LRBAs must comply with the Superannuation Industry (Supervision) Act 1993 (SIS Act) and regulations.

Examples of LRBA Arrangements

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#1: Residential Property Investment

An SMSF purchases a residential property worth $600,000 using $300,000 from its funds and borrowing the remaining $300,000 through an LRBA from a financial institution. 

The property is held in a separate bare trust until the loan is fully repaid. 

Rental income from tenants helps in servicing the loan, and over time, the property appreciates, boosting the retirement savings of the SMSF members.

#2: Commercial Property for a Business Owner

A small business owner wants their SMSF to purchase a commercial property valued at $800,000 to lease back to their business. 

The SMSF contributes $400,000 from its fund and secures a loan for the remaining $400,000 through an LRBA. 

The business pays rent at a market rate to the SMSF, which is then used to service the loan repayments, providing both an investment return and business premises.

#3: Investment in Shares

An SMSF decides to invest in a portfolio of blue-chip shares worth $500,000. 

It uses $250,000 from the fund and borrows the remaining $250,000 under an LRBA. 

The purchased shares are held in a separate trust, and dividends generated from the shares contribute to the loan repayments.

Benefits of Using an LRBA in an SMSF

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LRBAs offer several advantages to SMSF trustees, including:

• Access to Higher-Value Investments: SMSFs can purchase high-value assets, such as real estate, that might be unaffordable. 
• Tax Benefits: SMSFs benefit from concessional tax treatment, including a maximum tax rate of 15% on rental income and a potential capital gains tax discount after holding the asset for over 12 months 
• Asset Growth and Retirement Wealth: Borrowing enables the SMSF to acquire growth assets that may appreciate over time, increasing retirement savings.

Risks and Considerations

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While LRBAs offer potential benefits, they also come with risks and regulatory requirements that trustees must carefully consider:

• Loan Repayment Risks: SMSFs must ensure adequate cash flow to repay loans, even during market downturns or rental vacancies. 
• Liquidity Issues: LRBAs can tie up a significant portion of the fund’s assets, reducing liquidity for other obligations such as pension payments. 
• Strict Compliance Requirements: Non-compliance with SMSF borrowing rules can result in penalties or the loss of concessional tax benefits.

Who Can Provide LRBA Loans?

LRBA loans can be obtained from banks and financial institutions or related-party lenders(such as members of the SMSF). However, to avoid breaching superannuation laws, borrowing from a related party must be on arm’s length terms.

Recent Regulatory Changes

Regulators such as the Australian Taxation Office (ATO)and the Australian Securities and Investments Commission (ASIC)have been closely monitoring LRBAs due to concerns about fund liquidity and compliance risks. Trustees should stay informed about regulatory changes and seek professional advice when considering an LRBA.

Final Thoughts

Limited Recourse Borrowing Arrangements can be a valuable tool for SMSF trustees looking to leverage their retirement savings into high-growth assets. However, careful planning, compliance with superannuation laws, and a solid risk management strategy are essential. 

Before entering an LRBA, it’s recommended to consult with a qualified SMSF advisor to ensure the strategy aligns with your fund’s objectives.

If you’re considering an LRBA for your SMSF, our team of experts can guide you through the process to ensure compliance and optimal financial outcomes. Contact us today to learn more!

Disclaimer

The views expressed in this publication are solely those of the author; they are not reflective or indicative of licensee’s position, and are not to be attributed to the licensee. They cannot be reproduced in any form without the express written consent of the author.

Elliot Watson Financial Planning Pty Ltd and its advisers are Authorised Representatives of RI Advice Group Pty Ltd, ABN 23 001 774 125 AFSL 238429.

The information (including taxation) in this article does not consider your personal circumstances and is of a general nature only – unless otherwise stated. You should not act on the information provided without first obtaining professional advice specific to your circumstances.

Article by Vikas Modgil* – Senior Financial Adviser