A bare trust plays a crucial role in an SMSF borrowing arrangement, particularly when purchasing property through a Limited Recourse Borrowing Arrangement (LRBA). This structure allows the SMSF to borrow money to acquire a single acquirable asset, which is then held in trust. The SMSF trustee retains the beneficial interest in the asset, while the legal title is held by the bare trustee.
Under the Superannuation Industry (Supervision) Act 1993 (SIS Act), an SMSF is permitted to borrow funds under specific conditions, primarily through an LRBA. The bare trust is integral to this arrangement, ensuring that the asset purchased is held separately from other SMSF assets until the loan is fully repaid. It's important to note that the bare trust only holds the legal title and does not have any rights to the asset's income or capital gains.
One common misconception is that the bare trust itself owns the asset. In reality, it merely holds the title, while the SMSF retains the beneficial ownership. This distinction is vital for compliance and tax purposes.
Take a practical example: Consider an SMSF that decides to purchase a residential property valued at $800,000 in Melbourne using an LRBA. The SMSF contributes $300,000 from its funds and borrows $500,000 from a lender. A bare trust is established to hold the legal title of the property. The SMSF, as the beneficial owner, receives rental income, which is used to repay the loan. Once the loan is repaid, the legal title can be transferred to the SMSF.
In our experience reviewing thousands of properties across Australia, we often see investors overlook the importance of correctly setting up a bare trust. Errors in trust deeds, such as naming the wrong entity as the trustee or failing to specify the asset correctly, can lead to compliance issues. Moreover, the distinction between legal and beneficial ownership is frequently misunderstood, leading to potential tax implications.
The answer can differ depending on your situation. For instance, if your SMSF acquires a property before the 2017 budget changes, the rules regarding plant and equipment depreciation may differ. Similarly, if the asset is a commercial property, different regulations may apply. Additionally, the involvement of related parties as guarantors or lenders in the arrangement can complicate the structure.
When dealing with SMSF borrowing arrangements, professional advice is crucial. The specifics of trust law, superannuation compliance, and tax implications require the expertise of both a Chartered Quantity Surveyor and an accountant. Together, they ensure that the arrangement is not only compliant but also optimised for tax efficiency.