How Does an LRBA Work? Complete Guide for SMSF Trustees

Limited Recourse Borrowing Arrangements (LRBA) paves the way for super fund (SMSF) trustees to loan some funding to acquire a new property.

One main advantage of this is that you can sell the properties you've bought if you default on your existing mortgage. However, all remaining assets in your SMSF will stay protected.

Besides, there are a handful of lenders out there who offer SMSF loans. If you want to venture into LRBA to keep your retirement fund safe, here are some crucial facts you need to know.

Proper LRBA structuring is essential for successful SMSF property investments

What is an LRBA?

The Superannuation Industry (Supervision) Act of 1993 restricts SMSF trustees from borrowing any loan unless through a limited recourse borrowing arrangement (LRBA), as outlined in ATO guidelines.

In other words, you need to set up a bare trust as a separate entity so you can legally acquire the residential or commercial property in place of the super fund.

We call this a single acquirable asset, which also covers multiple units in one title, like a commercial building and a car park that can be separately sold.

Using a bare trust with an LRBA, you can legally invest in property on behalf of your SMSF. However, you can only acquire one commercial/residential property for every bare trust.

LRBA Key Point

A bare trust must be established as a separate entity for each property investment, allowing you to legally acquire property through your SMSF while limiting recourse to only that specific asset. This structure is defined in ATO's Self Managed Superannuation Funds Ruling SMSFR 2012/1.

How Much Can You Borrow?

The amount you can borrow depends on whether you're purchasing residential or commercial property:

1. Residential Property: You can apply for a limited recourse loan to borrow around 75-80% of the residential property value you want to buy, according to ASIC's MoneySmart borrowing guidelines.
2. Commercial Property: With an LRBA, you can loan up to 70% of a commercial property's value.
3. Discounts: Some banks and lenders can offer discounts and margins to their SMSF residential loan rates. But keep in mind that these discounted rates vary significantly.

For more information on borrowing in an LRBA for your SMSF, learn about SMSF loan deposit requirements or contact our specialist mortgage brokers today.

Residential Property

1. 75-80% LVR available
2. Potential rate discounts
3. Single asset per trust

Commercial Property

1. Up to 70% LVR
2. Business premises funding
3. Potential tax benefits

Are there advantages in limited recourse loans?

Absolutely! Here are some of the most common advantages of an LRBA loan:

1. Expand your SMSF investments into other ventures, including assets such as commercial properties.
2. Help business owners purchase a commercial space
3. Protect other SMSF assets from recourse. The lender will acquire other assets to cover the losses from selling the property you bought using the loan.
4. Enjoy tax benefits, including capital gains tax concessions (CGT) that you can get for as low as 10% if you've held the property for over a year, as outlined by the Australian Taxation Office.
5. Use concessional super contributions to pay off your loan faster, given that you're not nearing the retirement age.

What are the cons of limited recourse loans?

Before you head out and apply for an LRBA, ensure that acquiring the commercial or residential property will give you more benefits than risks, especially during your retirement.

Consider some important factors such as capital growth and rental income and whether those are worth more than the mortgage interests and maintenance/repair costs.

That said, here are some disadvantages of an LRBA:

1. Investors will heavily rely on the property market
2. If the property consumes a large sum of the SMSF's assets, the risk of illiquidity increases. Learn more about SMSF loan liquidity requirements.
3. In case of a default, if the property cannot be quickly sold, it may affect the super fund's capacity to meet its responsibility to beneficiaries.
4. Superannuation policies and legislation regularly change. Hence, it can be hard to keep up with the changes and may lead to expensive fines if policies are breached, as warned by Australian Taxation Office guidance.

It's crucial to carefully weigh the potential benefits against the risks of an LRBA, particularly considering your specific retirement timeframe and financial goals. If you already have an LRBA and are looking for better rates, check our guide on refinancing an SMSF loan.

Do I need a personal guarantee to qualify?

Yes. Almost all commercial banks and lenders require personal guarantees from SMSF trustees before issuing an LRBA loan or even approving an application. This requirement is standard practice across the lending industry, as noted by ASIC's MoneySmart.

This personal guarantee is a legal promise from each trustee to ensure that the loan will be repaid. In other words, if the SMSF cannot repay the loan, the trustees become legally accountable. This is because despite the "limited recourse" element of the loan relative to the SMSF's other assets, the bare trust structure still requires trustee guarantees.

It doesn't mean that personal guarantees should contribute to the mortgage repayments every month.

It only means that the bank/lender can look for you if the asset fails to cover the said loan.

For LRBAs, most banks and lenders are focused on minimising financial risks than keeping tight competition. That's why limited recourse loans tend to go after your assets if the super fund defaults on its repayments.

Careful planning is essential when setting up LRBA structures for SMSF property investment

Can I invest in property using my SMSF?

You must evaluate whether your SMSF can cover a property investment before heading out and applying for a limited recourse loan. The Australian Prudential Regulation Authority (APRA) recommends thorough assessment of your fund's investment strategy before making such decisions.

For that, we highly advise speaking with your accountant and seeking professional help to get legal and financial advice.

Our mortgage brokers at LeaseDocLoan can also help you evaluate your current financial situation and discuss your options as to whether an LRBA will best suit your long-term investment plan.

What will happen after the loan settlement?

During the settlement, your bank/lender will hand over the loan amount to the bare trust. Then, the super fund will begin paying off the balance of the purchase value.

After acquiring the property, it will be registered under the name of the bare trust's trustee. The trustee should grant a mortgage and guarantee that the bank/lender has the absolute right to take the asset and sell it in case of loan default.

Furthermore, the SMSF should earn the property's income through the bare trust structure. But keep in mind that the super fund should also cover the property's maintenance costs and mortgage payments.

When can I opt-out of the LRBA?

You can sign out of the limited recourse agreement as soon as you finished paying off the loan, according to ATO regulations.

After that, you can keep the property in your bare trust or close the account and transfer the asset to the SMSF trustee instead.

Nevertheless, keeping legal advice and tax advice on these matters is crucial to ensure you're heading on the right path and that your decisions are in your SMSF's best interests.

Is the government banning LRBAs?

The Australian Government isn't banning limited recourse borrowing arrangements. But the idea had been in talks for some time between the government and multiple industry agencies.

In 2015, the Financial System Inquiry (FSI) recommended prohibiting lending to super funds via limited recourse arrangements. However, the Australian government believes that there is insufficient data to justify the total ban.

Instead, the Self-managed Independent Superannuation Funds Association (SISFA) took shape, supporting the government's decision to allow LRBAs.

Today, LRBAs remain an option for super funds in establishing a properly structured long-term and retirement plan under the SIS Act.