With the recent changes to superannuation legislation, more investors are looking for alternative strategies to accumulate wealth in their superannuation fund. Purchasing your practice premises via your Self-Managed Superannuation Fund (SMSF) can still be a viable and attractive option.
The introduction of Limited Recourse Borrowing Arrangements (LRBAs) in 2007 made it possible for SMSFs to borrow funds to purchase an investment asset in some circumstances provided certain criteria are met.
What assets can be acquired under an LRBA?
A SMSF may only enter into an LRBA to purchase certain assets as outlined in section 67A of the Superannuation Industry (Supervision Act) (“the SIS Act”). Borrowings made by a SMSF are authorised provided that:
- The borrowing is applied for the acquisition of a single acquirable asset
- The acquirable asset is held on bare trust
- The SMSF has a beneficial interest in the acquirable asset and a right to legal ownership (i.e. the SMSF is entitled to all income, expenses and capital growth related to the asset)
- The recourse of the lender is limited to the asset which is the subject of the arrangement. This ensures that the other assets of the SMSF are not exposed in the event of default.
Examples of assets that may be purchased under a LRBA include: listed securities, commercial property (eg. medical consulting rooms), and residential property.
LRBAs in practice
A medical practitioner may use an LRBA to purchase a commercial property such as consulting rooms, which can then be rented back to the medical practice at commercial rates under a properly documented lease agreement.
Where the medical practitioner already owns his or her consulting rooms, the SMSF may be used to acquire the asset from the owner – freeing up the owner’s accumulated equity. The small business CGT concessions may be used to minimise any capital gains tax on the transaction.
A LRBA can also be used to acquire other types of investments – such as residential rental properties. However, while business premises can be rented to SMSF members or their associates, residential properties cannot.
Purchasing assets through a SMSF is often used as part of a tax effective wealth accumulation strategy for the following reasons:
- SMSFs are generally subject to an income tax rate of just 15%
- Tax on SMSF capital gains may be levied at just 10%
- Where the SMSF pays pensions to its members, its tax rate may be reduced to nil
An LRBA enables a SMSF to purchase assets which it would otherwise be unable to acquire; particularly where a SMSF has insufficient available funds.
For example, an SMSF with $500,000 of available cash may be able to purchase an asset worth $1,000,000 by borrowing the additional 50% from a financial institution or related party to the SMSF. This may dramatically increase the SMSF’s ability to leverage off its existing asset base to acquire substantial investments.
While the benefits of an LRBA are clear, it is important to consider some of the intricacies around these arrangements:
- The cost of setting up an LRBA can be significant – typically between $3,000 and $10,000, but potentially even more in complex situations
- The SMSF will be required to comply with rules governing LRBAs both at the commencement of the LRBA and for the duration of the borrowing
- The SMSF will need to ensure that it is able to fund the borrowing – through member contributions and SMSF earnings
- The tax benefit on the interest expense is only 15% versus up to 46.5% if a negatively geared asset was acquired outside of superannuation by an individual and so a LRBA only “stacks up” if certain parameters (including in respect of capital growth rates) are met.
- Consider the impact of LRBA repayments on your Transfer Balance Cap
Professional advice must be sought before entering into an LRBA arrangement. If you are interested in investigating how an LRBA or other superannuation strategies could help you accumulate more wealth please contact your local William Buck Wealth Advisor.
Should you wish to discuss any aspects of the above please contact Tricia Kleinig of William Buck on (08) 8409 4333. Tricia is an SMSF Specialist Advisor who is licensed to provide financial advice.
Disclaimer: The contents of this article are in the nature of general comments only, and are not to be used, relied or acted upon with seeking further professional advice. William Buck accepts no liability for errors or omissions, or for any loss or damage suffered as a result of any person acting without such advice. Liability limited by a scheme approved under Professional Standards Legislation.