To get its capital gains tax and negative gearing changes through the Parliament, the Government agreed to act on one of the Greens’ longstanding bugbears : SMSFs borrowing to buy residential property.
Obviously this is bad news for those about to embark on a borrowing – so what exactly is happening and how will it impact SMSFs?
What is changing?
In all super funds, the starting position is that super funds can’t borrow.
The only reason “Limited Recourse Borrowing Arrangements” (or LRBAs) even exist is that they’re a specific exception to this general rule that was introduced in 2007. (And I should note – it’s an exception that applies to all super funds, not just SMSFs. SMSFs just tend to use the exception differently.)
This particular exception only allows borrowing to occur if the arrangement meets a number of strict conditions – including that the borrowed money is used to buy a single “acquirable asset”. Until now, the term “acquirable asset” has been broad enough to buy pretty much anything a super fund could normally invest in. In practice, constraints presented by the addition of the word “single” has meant that most borrowings related to property.
What will change under the proposed amendment as an extra condition will be added – if the single acquirable asset is real property, then it must be “business real property” (which is a defined term for super purposes).
When will the LRBA ban start?
It will only apply (commence) from the 45th day after the whole Bill was passed and received Royal Assent (26 June 2026). That means it will start from 10 August 2026. So it won’t catch acquisitions occurring right now or acquisitions that have happened in the past.
It specifically doesn’t stop people refinancing existing LRBAs over residential properties or acquisitions where contracts are exchanged before 10 August (even if settlement doesn’t occur until after 10 August).
What does it mean?
This isn’t just a ban on LRBAs for residential property, it’s a ban on LRBAs for any real property that’s not business real property.
And remember some property that feels like commercial property falls short of being business real property. For example, a mixed use property such as a shop with a residential flat upstairs, isn’t business real property. One of the requirements for business real property is that it’s used “wholly and solely” in the business with some modest exceptions.
For most people, that means buying residential property with a loan in their SMSF will no longer be an option.
It won’t matter whether the residential property is a new build or established property. While these are treated differently for some of the Government’s other changes (negative gearing, for instance, will still be allowed for new builds just not existing properties), there’s no distinction in the LRBA ban.
Some paradoxes about residential property
Some property 'looks' residential but is actually business real property. The classic example is a home that’s used as a doctor’s surgery. As long as it’s being used wholly and exclusively in a business (the doctor’s business), it’s business real property and could still (even under the new ban) be purchased using an LRBA.
Sometimes residential property is business real property for a time but not forever. In the example above, the use of the property could change (for example, the doctor moves out and the SMSF decides to refurbish and return the home to its original use as a home). That would be a problem.
Other times it depends on who owns the property. For example, someone who is running a business renting out investment properties can argue – if the scale of the operation is large enough and it meets other 'business' tests – that a house is 'stock' in that commercial enterprise and therefore business real property. Occasionally people use this argument to allow them to transfer an investment property their business already owns into their SMSF (as SMSFs can acquire business real property from members and related businesses but not other property).
But once it’s in the fund, if it’s no longer part of the business enterprise it presumably stops being business real property. I imagine that means even this arrangement is ruled out in future but we’ll have to see. Interestingly if you applied a genuinely 'point in time' test to an arrangement like this (ie, exactly what is being bought by the SMSF when it takes out the loan?) it would be hard to argue that it’s business real property for the acquisition rules but not the borrowing rules. That said, I suspect very few people will be able to take advantage of it in any case.
What’s still allowed?
SMSFs can still buy residential property without a loan.
If they want to borrow, they can still buy other things under an LRBA:
- Commercial property that meets the business real property definition (but as above, it would need to keep meeting it)
- Shares or units in managed investments – as long as it treats the whole holding as a single indivisible investment (ie, the SMSF couldn’t sell part of the holding while the LRBA was in place)
Is it too late to get in now?
Unless a transaction is already well underway I suspect it is. Certainly those who haven’t yet set up an SMSF are highly unlikely to be able to get everything in place before the ban takes effect.
What does the future hold?
It will be interesting to see what this change does for SMSF growth – which is currently at unprecedented levels.
Looking at the SMSF sector as a whole, the ATO’s latest statistics report that around 6.7% ($67 billion) of all assets in all SMSFs was invested via an LRBA at 30 June 2024. But this doesn’t represent the debt, it represents the value of the assets SMSFs have bought with their loan (the actual debt is a lot lower - $26 billion). It’s also worth noting that around 40% of these LRBAs related to non residential property – which will still be allowed.
I would love to know whether the statistics for newly established funds are materially different – are the people currently flocking into SMSFs doing so because they intend to borrow and buy residential property or are they doing something different?
Or has the ability to borrow perhaps piqued their interest but once they learn about all the things an SMSF can do, they don’t go ahead with the borrowing and instead invest their SMSF elsewhere?
I guess we’ll have to wait and see.
Meg Heffron is the Managing Director of Heffron SMSF Solutions, a sponsor of Firstlinks. This is general information only and it does not constitute any recommendation or advice. It does not consider any personal circumstances and is based on an understanding of relevant rules and legislation at the time of writing.
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