Borrowing inside Self Managed Superannuation Funds

Posted in Wealth
01/08/2012 Level One

It is now possible to borrow monies within a SMSF to purchase assets, commonly property. Both residential and commercial properties can be purchased and used for investment purposes.

Structure of a Borrowing Arrangement inside SMSF

While substantially similar to borrowing personally, there are several notable differences when you borrow in your SMSF.

Firstly, the loan must be established on a limited recourse basis. Effectively, this means the lender’s recourse in the event of default is limited to the single asset acquired with the borrowed funds and not other assets of your SMSF.

Secondly, a separate ‘security trustee’ (e.g. a company) is established to hold the asset ‘on trust’ for your SMSF until the loan is repaid. Whilst the security trustee is the legal owner of the asset, your SMSF retains beneficial ownership during the loan period. When the loan is repaid in full, the legal title must be transferred to your SMSF.

Further, although the ‘security trustee’ is interposed between the asset and your SMSF, the role played by the security trustee is minimal. For example, all income and expenses related to the asset are deposited into, and paid directly from, your SMSFs bank account and not via the security trust.

Thirdly, you can only purchase a single acquirable asset with each borrowing arrangement. This means that if you purchased a block of land with borrowed monies this would be seen as a single acquirable asset. The construction of an investment property on the land, where again monies were borrowed, would be treated as a second single acquirable asset.

Because of this unique structure, standard loan products offered by financial institutions cannot be used by an SMSF. Bank lenders have developed special loans, specific for this purpose.

The borrowing structure for SMSFs is shown in the following diagram:


Financing Options

You also have three options with regard to financing:

  • Borrow monies from a bank;
  • Borrow monies from a related party
  • A combination of both.


Borrow from a Bank

Once you established the SMSF, the security trustee, and have the equity available (i.e. rolled your member account balances into the SMSF) you can then approach a bank to arrange your borrowing arrangement.

As these borrowing arrangements are more complicated that simply borrowing personally, you may find this process takes up to a month to be finalised.

The main advantage of borrowing from a bank compared to borrowing from a related party is that you are not locking up excess cash/equity from other entities that may be needed elsewhere.


Borrow from a Related Party

Utilising a loan from a related party of the SMSF instead of obtaining a loan from a bank can provide the following advantages:

  • Reduced upfront costs;
  • Reduced ongoing costs;
  • Flexible repayment terms;
  • Interest is paid to a related party rather than banks with multi-billion dollar profits;
  • Younger SMSF members can inject capital to purchase property without it being trapped until they retire;
  • High value assets can be transferred to a SMSF without exceeding the contribution caps and tax deductible contributions can be spread over a number of years;
  • Ability to correctly and legally develop property within a SMSF.


Combination of Bank and Related Party Loans

This option is quite beneficial in the event that the SMSF does not have the required capital to satisfy the lenders LVR.

Here the SMSF’s members or a related entity, such as a company where you are a director, can loan an amount to the SMSF, with the SMSF then borrowing a smaller amount from the bank.


Borrowing Capacity & Loan Servicing

In relation to SMSF property loans, the LVR, or percentage of a property’s value the bank will lend, is often lower at around 65%, compared to around 85% for loans held externally. You would need to check this with your bank.

The level of gearing you choose should suit your circumstances. In most cases, it is more effective to positively gear inside superannuation. This is due to the flat concessional tax rate of 15% inside superannuation.

Negative gearing suits high income earners where the losses generated by negative gearing can lower the individual’s marginal tax rate from as high as 46.5% to nil.

To achieve positive gearing, you should ensure that your superannuation contributions are repaying both the principal and interest as well as servicing any costs associated with the property.


Get In Touch

We welcome you to contact us for more information
about our services.

Follow us