Limited recourse borrowing arrangements (LRBAs) allow self-managed super funds (SMSFs) to borrow money to purchase a single asset, such as a residential or commercial property. This type of borrowing is structured so that the lender's recourse is limited to the asset purchased. If the loan defaults, the lender cannot claim against other SMSF assets.
How Limited Recourse Borrowing Arrangements Work
Under the Superannuation Industry (Supervision) Act 1993, LRBAs enable SMSFs to acquire assets that would otherwise be beyond their financial reach. The borrowed funds can only be used to purchase a single acquirable asset, like a property or a collection of identical assets with the same market value. The asset is held in a separate trust, and the SMSF gains a beneficial interest.
A critical misconception is that all SMSF assets are at risk in case of default. However, under an LRBA, only the asset purchased is at risk, protecting other fund assets from creditors. This structure must comply with strict legal and regulatory requirements, including ensuring the loan is non-recourse and the asset is held in a separate trust.
How This Works in Practice
Consider an SMSF looking to purchase a commercial property in Melbourne valued at $800,000. The SMSF has $400,000 in cash but wants to leverage its funds to acquire the property. By setting up an LRBA, the SMSF borrows the remaining $400,000. The property is held in a separate trust, and the lender's recourse is limited to this asset.
Assuming a 5% interest rate on the $400,000 loan, the annual interest cost is $20,000. If the property generates a rental income of $50,000 annually, the SMSF can cover the interest and contribute to the loan principal. At a 37% marginal tax rate, the tax saving on the interest expense would be approximately $7,400 in the first year, enhancing the fund's cash flow.
Professional Insight
In our experience, one common oversight is failing to set up the separate trust correctly, leading to compliance issues. Another frequent issue is not understanding the impact of LRBAs on cash flow; investors often underestimate the ongoing costs. It's also critical to consider the long-term strategy—an LRBA is not suitable for short-term investments. What most investors don't realise is the importance of aligning the investment with the fund's overall strategy and risk profile.
When Does the Answer Change?
When Should You Seek Professional Advice?
Given the complexities of LRBAs, it's essential to consult both a Chartered Quantity Surveyor and a financial advisor to ensure compliance and strategic alignment. A QS can help assess the property's value and depreciation potential, while an accountant can advise on tax implications and fund strategy. Individual circumstances, such as fund size, member age, and retirement goals, significantly affect the suitability of an LRBA.