In September 2007 the law governing self-managed superannuation funds (SMSFs) was amended to allow SMSFs to borrow to purchase assets (subject to certain conditions). The conditions of the arrangement are:
(a) The borrowing is limited recourse – meaning the lenders only security is the asset purchased
(b) The SMSF could ordinarily acquire the asset without borrowing
(c) A third party (Security Trustee) holds legal title of the asset in trust for the SMSF. The SMSF then has a beneficial interest and a right to call for a transfer of legal title when the loan is repaid and the mortgage discharged.
So how does it work?
Let’s say your SMSF wants to buy a property but cannot fund the full purchase price. It does however have enough funds for a percentage of the purchase price. The SMSF can purchase the property under an instalment arrangement, subject to certain criteria (see above). The SMSF provides the funds for a partial payment on the property, pays all the relevant fees and borrows the remaining funds to pay the balance.
The property is owned by a separate Security Trust with your SMSF having a beneficial entitlement to it. The Security Trust may then lease the residential property to tenants on commercial terms. The Security Trust receives lease payments from the lessee and additional instalments from your SMSF. These are used to pay expenses and loan repayments relating to the premises.
A mortgage over the property will be the security for the loan under a limited recourse loan. In the event of a default, the lender only has recourse to the property and any security provided by a guarantor, but cannot claim on any other assets within the SMSF.
After the loan is repaid, the SMSF has the right to acquire legal ownership of the property.
The arrangement will be entered into by:
- TheSMSF, as borrower
- The Security Trustee, as guarantor and mortgage provider
- The bank, as lender
- Guarantees from the members acting as their personal capacity as guarantors.
Your other SMSF assets funds are secure, as the lender only has recourse on the asset purchased and held by the Security Trust.
Rental income from the property and superannuation contributions are used to help pay off the loan. The Security Trust is able to offset the loan interest and expenses against the rental income. The SMSF is entitled to any net income of the Security Trust.
It is important to remember that the SMSF trust deed must allow borrowing under an instalment arrangement. It is also important to remember that arrangements must be at arm’s length and transacted at market rates.
If you wish to discuss how your SMSF could borrow to purchase an asset using the borrowing concessions, please contact Ellingsen Partners.