For Adviser use only
Under an LRBA, the asset must be a ‘single acquirable asset’ which the fund is legally permitted to acquire and must be held in a holding trust with the self-managed super fund (SMSF) acquiring beneficial interest in the asset.
Once the loan is fully paid, the SMSF trustee has a right to acquire legal ownership of the asset. The lender and any entity (if any) providing a guarantee for the loan can have recourse in the event of default only to the asset held in the holding trust. The borrowed funds can only be applied towards the purchase, repair and maintenance costs of the asset and cannot be used to improve the asset.
Plus, an asset under a LRBA (LRBA asset) can only be replaced under limited circumstances.
SMSFR 2012/1 provides clarity on the ATO’s view of what is a single acquirable asset and what it considers as repairs, maintenance and improvements.
A single acquirable asset can be any type including property, shares, units and collectibles. It may also include a collection of identical assets with the same market value under one LRBA such as units in a single unit trust or shares of a single class in a single company.
Such collections of assets must be dealt with as one asset. For example, disposing some shares from the parcel of shares acquired under a LRBA is prohibited. The whole collection must be purchased or disposed of within one transaction. Any shares acquired as part of a dividend reinvest plan cannot be part of the arrangement.
Where a superannuation borrowing arrangement was entered into prior to 7 July 2010, a portfolio of different shares or units could be acquired and a disposal of part of the portfolio is allowed. Grandfathering applies for those arrangements.
Under the current borrowing rules, a fund is deemed to acquire a ‘single asset’ even if it acquires more than one asset as long as the assets cannot be dealt with separately or where any law prohibits the assets to be purchased or sold separately. For example, a house and land where a portion of the land is on a separate title and can be sold separately would not be regarded as a single asset.
Conversely, a factory built across two titles of land would be regarded as a single asset as the factory is not capable of being split into portions and sold separately.
Similarly, the purchase of two residential strata units under a LRBA is not allowed by the rules even if the vendor refuses to sell these separately whereas a strata unit and a garage on separate titles would be a single acquirable asset if State laws require they be sold together.
Where there is more than one acquirable asset there is scope for the SMSF to acquire these under separate LRBA arrangements.
According to SMSFR 2012/1, the rules specifically allow borrowed money to be used to repair and maintain a LRBA asset but not for improvements. ‘Repair’ includes restoring the asset to its former state, correcting any physical defects, damage or deterioration caused by wear and tear or deliberate damage so that its functional efficiency is restored.
Repair may include replacing part of an asset but not replacing the whole asset. For example, equipment can be repaired by replacing certain parts to bring it back to normal working order but it cannot be completely replaced by another.
‘Maintenance’ refers to work done to prevent or anticipate defects, damage or deterioration to keep the asset in good working order.
Work done to significantly improve an asset’s functional efficiency and value is an ‘improvement’. Although borrowed money cannot be used for improvements to a LRBA asset, money from other sources such as super contributions or fund earnings may be used.
It’s important to determine whether an asset is repaired, maintained or improved if borrowed moneys are used to pay for the work. Distinguishing between repair or maintenance and improvement is a question of fact and degree.
In determining whether the work is an improvement, you must refer to the qualities and characteristics of the asset when it was originally acquired at commencement of the LRBA. For example, restoring a burned down kitchen or replacing a broken window is a repair, while extending a kitchen or adding an additional bedroom or swimming pool to a property is an improvement.
Renovating a property greatly enhances its functional efficiency and market value. It’s considered an improvement and cannot be paid with borrowings.
Care must be taken if the LRBA asset is purchased in major disrepair as any modifications rather than repairs to significantly increase its functions are an improvement. Improvements cannot be such that the qualities and characteristics of the LRBA asset change considerably so that the replacement asset rules are breached.
An old four bedroom house on a block of land on one title is a single acquirable asset as the house cannot be acquired without the land on which it is on. If the house is burned down and insurance proceeds are used to build a similar house, the new house restores part of the asset and may be an improvement as a new house generally would have a better functional efficiency and higher value than an old house. It is an improvement funded by insurance proceeds (not borrowed money) and allowed by the rules.
Only certain LRBA assets such as shares, units and instalment receipts can be replaced. Replacement is permitted only under a takeover, merger, demerger or restructure of the company or unit trust. Replacing a LRBA asset other than under these circumstances breaches the rules and therefore, replacing a real property asset is not permitted.
Although improvements to a property are allowed, they cannot be made to the extent that its qualities and characteristics change and the asset becomes a ‘different’ asset. Improvements that make an asset a ‘different’ asset are allowed only after the LRBA has been terminated (eg after full payment of the loan and the asset has been transferred to the SMSF).
If the four bedroom house in the first example above is replaced by two bedroom duplexes and the land subdivided into two titles, the asset’s characteristics change significantly because the house is replaced by a dual occupancy building. Plus, the asset is no longer a single acquirable asset because the duplexes can be sold separately. This arrangement wouldn’t be allowed while borrowings are still outstanding under the LRBA.
SMSFR 2012/1 cites numerous examples for when an asset is a single acquirable asset and when it’s not, when work done is a repair, maintenance or an improvement, and where an asset becomes a different asset.
The purchase of a strata unit ‘off the plan’ where the SMSF uses its own funds for the initial deposit and borrowed funds for the payment upon completion is allowed. The LBRA commences once the unit is completed and the balance is paid with borrowed money.
The arrangement does not give rise to the ‘replacement asset’ issue as the asset acquired at commencement is the completed unit. The ruling mentions that furnishings are a collection of different assets which are removable and hence not part of the single acquirable asset. Therefore, these cannot be paid for by borrowed funds and not part of the LRBA.
The purchase of a house and land where borrowed money pays for instalments at various stages of completion will not meet LRBA requirements. Under this arrangement the asset acquired at commencement is the land. Subsequent drawdowns used for instalments as the house is built are used to purchase services and various materials, which will not be a single acquirable asset nor a collection of identical assets. In addition, borrowings cannot fund improvements to the asset. Building the house changes the qualities and characteristics of the block of land such that the replacement asset rule is breached.
However, if the SMSF entered into a contract to acquire a house and land package (ie land with a yet to be constructed house), and settlement occurs once construction of the house is complete, the deposit and payment on settlement can be funded under a single LRBA.
When advising your clients on LRBAs, it’s important to consider:
whether the asset acquired under a LRBA is an asset the SMSF is permitted to acquire
whether the LRBA asset is a ‘singe acquirable asset’ or a collection of identical assets
multiple LRBAs can be used if the SMSF intends to acquire more than one acquirable asset
the terms and conditions around the acquisition of the LRBA asset
characteristics and qualities of the LRBA asset at commencement
the nature of work to be done (if any) to an LRBA asset
source of funds for repair, maintenance or improvement costs
improvements that make an asset a ‘different’ asset can be done after the LRBA has been repaid and the asset has been transferred to the SMSF.
Next: SMSF investments
For adviser use only
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