The ability of a Self Managed Superannuation Fund (SMSF) to borrow through a “limited recourse borrowing arrangement” presents a potential opportunity for investors to create considerable wealth within the tax concessional environment of a SMSF. In 2007 the government changed the laws allowing SMSF trustees to borrow to acquire shares, residential and commercial property. These rules were further enhanced by the government in 2010.
Many of our clients have sought advice on how to structure tax effective loans for their SMSF. With a steady increase in SMSFs now borrowing to acquire property, we thought it would be great to explain SMSF borrowing, the benefits of SMSF borrowing and provide our best SMSF borrowing strategies.
What does SMSF Borrowing look like
Surprisingly borrowing through a SMSF is not difficult. All of the major lenders and mortgage brokers offer a wide range of products. There is a little bit more documentation to complete but many banks treat the loan as a residential or commercial investment property loan with competitive LVR’s (loan to value ratios) and interest rates. One exception though as per stipulated by the superannuation laws, is that the loan must be non-recourse.
Julie’s Top Five Benefits of SMSF Borrowing:
There are a number of important advantages for a SMSF trustee that successfully carries out a borrowing arrangement to acquire shares, managed funds, residential property or commercial property:
- It maximises the wealth effect in the SMSF in times when assets of the fund are rising. However care should be had in falling markets – although there is the benefit that there are no margin calls due to the non-recourse nature of the loan.
- The borrowing can be for a short period or for a period of up to 20+ years (if related party financing is used) allowing it to be structured to the underlying circumstances of the fund members.
- Members and related businesses can act as lenders provided that all lending is at arm’s length. This means using equity in another non-super asset or credit line facility to on-lend to a SMSF.
- It increases the flow of non-contribution style funds into the SMSF particularly where the members of the fund have used up their contributions capacity. Care must be had to ensure that there is a genuine borrowing and not a contribution arrangement otherwise the Commissioner may deem the borrowing to be a non-concessional contribution.
- Future income and capital gains on underlying assets are taxed concessionally in a SMSF and may even be tax free where the assets are held for pension purposes.
Julie’s Top Five SMSF Borrowing Strategies:
Here are some ideas and strategies you may consider:
- Transferring shares or property into a SMSF – a member may wish to transfer a parcel of listed shares, managed funds or business real property that they or a related party such as a family trust owns into the fund by way of a borrowing arrangement. But watch out for CGT – with hindsight this would have been a great strategy at the bottom of the market. Stamp duty may also be applicable on the transfer.
- Buying big – borrowing lets the Trustee of a SMSF obtain leverage to acquire those assets that normally would be out of its reach. This may include large parcels of shares or commercial property.
- Transferring more assets into a SMSF – the contributions rules limit the $ amount of contributions that may be contributed to a fund. However if the member wants to transfer a large share portfolio or commercial property they own into their SMSF they can use loans as well as contributions. There are no set LVR requirements for related party loans subject to the arms-length rules.
- Acquire Business Property – where a family trust, company or partnership owns a property that the family business operates from this could be transferred to the SMSF as a mix of contributions and SMSF Loan by a related party. In certain circumstances the owner of the property may be able to use the small business CGT concessions in relation to the business property transfer.
- Use SMSF Loans regularly – once the trustee of a SMSF is comfortable using a SMSF Loan arrangement use it for all members of the fund and continuously to build up a portfolio of properties or shares.
As with all strategic opportunities it is critical to seek specialist SMSF and taxation advice so that all areas are covered off in a compliant manner and implemented effectively. It can be a costly exercise if not done properly. Should you wish to discuss any of the above strategies in any further detail please do not hesitate to contact Julie Dolan by email: Julie@nautiluslaw.com.au, or to arrange a conference with Julie please call (07) 5574 3560.