A few weeks ago the ATO issued a draft ruling enabling SMSFs to renovate and improve properties purchased under limited recourse borrowing arrangements. This ruling takes a very common sense approach and removes a lot of the confusion surrounding this issue. LRBA property improvements are possible provided a replacement asset is not created.
Please refer to my article Repairs vs improvements with property purchased under a SMSF loan.
Some aspects of this article are out of date
ATO Ruling 2012/1
Prior to this ruling being issued, it was not possible for a SMSF to improve property purchased through a limited recourse borrowing arrangement – regardless of the source of funds for the improvements. The ATO indicated that an LRBA property improvement or renovation would create a replacement asset, and the arrangement would need to be unwound – not a good outcome for SMSF trustees.
The ruling (SMSF 2012/1) confirms that LRBA property improvements are possible, that is a property owned by an SMSF where a limited recourse loan arrangement is in place (i.e. after 7 July 2010) to be renovated or improved, provided the following conditions are met:
- The source of funds for the improvements come from within the SMSF (i.e. not borrowed)
- A replacement asset is not created
Although we can now renovate and improve a property purchased under a SMSF borrowing arrangement, we need to ensure that the improvements are paid for by existing monies within the fund – not from borrowings.
This means if you are looking to purchase an older dilapidated property and renovate, you need to ensure that you have budgeted for all the relevant renovation expenses knowing that you will not be able to go back to the lender and borrow more as you can outside of super. To put it another way, you need to preserve as much cash within the SMSF as possible to enable the renovations to be paid out of the SMSFs own money.
What is a replacement asset?
Before this ruling was released, a key distinction was between what constitutes a repair, and what constitutes an improvement. The key question now is: When does an improvement create a replacement asset?
There are two main times where LRBA property improvements can create a replacement asset (which is prohibited with property bought under a limited recourse loan):
- The property is physically altered in such a way that is has a different function or purpose
- The legal rights associated with the property are altered
For example, converting a house to a dental surgery would be create a replacement asset as the property has a different function – i.e. it is no longer a residential home.
Any changes to the title of a property, such as sub-division or creating strata titles would also create a replacement asset(s), which is strictly not allowable under the limited recourse borrowing rules.
Taking into account the above limitations, there is still a very large scope for what can be done to a property under a limited recourse borrowing arrangement. Please refer to the ruling for further examples.
Single Acquirable Asset
Another positive change to come out of this draft ruling is the definition of a single acquirable asset has been updated.
In regards to property, this means where a single property spans across two or more titles and cannot be sold or dealt with separately, then it will be considered a single acquirable asset. Previously a separate custodian trust would be required for each title, but now the separate titles can be purchased as if they are one single property.
For example, a factory that covers two adjacent lots or an apartment with a car space on a separate title would still be considered a single acquirable asset.
A word of caution however – just because either the vendor or the purchaser want to deal with the separate titles as a single property, it doesn’t make it so. This is especially relevant with farming properties, as they are often comprised of a number of adjacent titles that can be dealt with individually.
LRBA property improvements summary
The issue of SMSF 2012/1 is a fantastic common sense development, and will provide property investors which a huge amount of confidence, certainty and flexibility when it comes to property acquisition (and LRBA property improvements). The ruling increased weight to the argument that a SMSF should be the preferred vehicle for purchasing any property investment that is going to be held long term.