SMSF limited recourse borrowings from related parties

Since September 2007 trustees of self managed super funds (SMSFs) have been able to purchase investments such as residential property, commercial property and listed share using gearing via a limited recourse loan provided the underlying asset is held by a custodian trust for the sole and exclusive benefit of the SMSF.  In addition an SMSF can borrow from related parties.  This article steps through limited recourse borrowing from related parties.

Article out of date

Refer to the following article for up to date information on this strategy: Related Party LRBA Safe Harbour

These limited recourse loans can come from the following sources:

1.       A bank or financial institution

2.       A related party (such as a member of the SMSF, family trust or company)

3.       A combination of both

Utilising a loan from a related party of the SMSF instead of, or in addition to, can provide the following advantages when compared to obtaining a limited recourse loan from a bank:

Reduced upfront costs

Reduced ongoing costs

Flexible repayment terms

Interest is paid to a related party rather than banks with multi-billion dollar profits

Younger SMSF members can inject capital to purchase property without it being trapped until they retire

High value assets can be transferred to a SMSF without exceeding the contribution caps and tax deductible contributions can be spread over a number of years

Ability to correctly and legally develop property within a SMSF

How does a member-financed limited recourse loan work?

When a SMSF borrows from a related party, even through the trustees don’t have to go through the rigorous and costly process they do if they where obtaining a loan from a bank lender, the limited recourse loan still must meet all the necessary conditions and restrictions placed on it under Section 67A of the SIS Act.

These conditions can be summarised as follows:

  1. The money borrowed must be used for the purchase of a single acquirable asset (including all associated costs) – must also be a new asset – the SMSF cannot already own it.
  2. The asset must be held by a custodial trust with the SMSF becoming the sole beneficial owner
  3. The SMSF can acquire legal ownership of the asset after making one or more payments on the loan
  4. The rights of the (related party) lender are limited to that particular asset only in the case of default – no other SMSF can be touched
  5. The asset cannot be subject to any other charge or encumbrance apart from the mortgage registered by the lender (part D above)

In addition, there are a number of other rules which the SMSF must comply with such as:

All dealings between the SMSF and its members need to be at arm’s-length (SIS s109) meaning all interest rates should be at market rates (this applies even with ATO ID 2010/162 which allows lower interest rates to be used) – this means a SMSF cannot borrow from a related party and be forced to pay interest back to that related party at excessively high rates

The purchase of the asset and the use of gearing in the form of limited recourse borrowing needs to be part of the investment strategy of the SMSF

The SMSF cannot acquire assets from a related party unless they are business real property at market value or listed securities at market value (SIS s66(2) and s66(2A)).  This means residential investment properties typically cannot be purchased from related parties.

There must be an appropriately documented loan agreement for the limited recourse loan from the related party.  This ensures that the money lent to the SMSF will not be considered a contribution.

The SMSF must still comply with the sole purpose test (SIS s62) meaning any investment or arrangement must be for the core purpose and benefit of the members on their retirement.

Strategies to maximise the benefit of member-financed limited recourse loans:

There are a huge number of strategic opportunities for existing SMSF trustees, their advisers and anyone looking to maximise their superannuation savings that are available with the use of member-financed limited recourse loans.

Below is an example – many of which are based on real life cases that demonstrate some of these great opportunities.

These examples are relatively advanced and in some cases require some assumed knowledge about income tax, capital gains tax and general superannuation and tax planning strategies.

Case Study: Best of both worlds – combining bank and related party loans

Melanie and Luke a couple in their mid-thirties and have $110,000 combined in their respective industry and retail super funds.

They are looking at purchasing a $300,000 commercial property; however they are struggling to be able to complete the purchase as with the bank lending them 65% of the purchase price, they don’t have enough to cover the associated loan fees, stamp duty and legal fees while still having a buffer to cover unexpected costs relating to the property.

Melanie and Luke however have personal cash savings of $25,000 which they can use to complete the purchase and give their new SMSF some much needed liquidity.  They are reluctant put this money into super as a personal contribution, so they loan it to the SMSF as a second / additional limited recourse loan.

Implications and advantages:

  • The purchase can be completed with extra liquidity to cover unexpected costs.
  • The SMSF will pay market rates of interest back to Melanie and Luke on the $25,000 loan
  • The SMSF can make lump sum repayments of the $25,000 loan back to Melanie and Luke – meaning that money is not trapped in their SMSF for at least 25 years until their retirement (which it would be if it was made as a member contribution).
  • The interest received by Melanie and Luke will be taxable income in their names.  This strategy could be modified slightly by using a family trust as the lender rather than individuals.  This would enable any taxable interest income to be distributed in the most tax effective manner.  The larger the amount of the member financed loan, the more important it is to choose the correct structure for the lending entity.
  • No charge or second mortgage can be registered against the title of the property for the loan from the members – only the loan from the bank for their limited recourse loan can do this.

Additional strategies using member financed limited recourse loans:

In addition to the above strategy, I have also put together 5 other example strategies SMSF trustees and their advisers can use in regards to member-financed limited recourse loans including:

– Use existing equity in your home to avoid direct borrowing from the banks and their excessive fees and charges on their limited recourse loans

– Using related party limited recourse loans to work within the concessional contribution caps and spread tax deductions over a number of years

– How small business owners can clear out a nasty Div 7A loan or unpaid present entitlement (UPE) and use the cash to fund an investment property purchase

– Legitimately develop property in your SMSF using a limited recourse loan from a related party

– Capitalisation of interest on a related party limited recourse loan to improve SMSF cash flow and enable younger investors to legitimately access a portion of future proceeds from the sale of the underlying investment

The above strategies are simply too large to fit in this one blog post, so at the end of the article I will let you know how you can download them as a PDF.


The six examples of how member-financed limited recourse borrowings can be used by SMSF trustees is not an exhaustive list.  The idea is merely intended to assist investors and their advisers come up with appropriate strategies and solutions for their situation.

If you are a personal investor are looking to use any savings or built up equity you have to purchase an investment property – either in your own name or in a trust – I strongly suggest you look at the option of utilising your existing superannuation savings via a SMSF with a member-financed limited recourse loan.

The major advantages of this strategy are:

You may already have the deposit lying unused in your poor performing industry or retail super fund

Combining your existing super with your personal savings will significantly increase your deposit, simultaneously reducing your borrowing costs and likely making your investment cash flow positive right from the start

Your age is not an excuse not to use superannuation – as the previous examples demonstrates, using a member-financed limited recourse loan enables you to legitimately have your SMSF repay any capital you inject into the purchase of property – it is not trapped in there until you retire

10% capital gains tax – need I say more!

Any additional or extra upfront and ongoing costs are more than offset by the tax savings and the ability for your superannuation savings to cover these costs

You can save for an investment property deposit using pre-tax income via salary sacrifice – which will accelerate your wealth creation

You can combine your super with your partner and family members (up to four members in one SMSF) to share the costs

If you have any questions, comments or feedback, please feel free to leave a message in the comment box below.  All comments and questions will be responded to.


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  • Kris_Evolved

    November 26, 2010 at 1:43 am

    You may have noticed that if you sign up for my newsletter, instead of receiving a link to download a copy of my eBook about member-financed limited recourse borrowings, you will receive the ‘SMSF Borrowing 101’ eBook instead.

    If you are interested in obtaining a copy of the member-financed limited recourse borrowings eBook case studies simply email me / send me a message via the website and I will send you a copy via email.

  • Pingback: Can you renovate a property purchased under a SMSF limited recourse loan?

  • Jennifers

    January 11, 2011 at 11:44 pm

    I am in a SMSF with one other person who recently died. We had loans for two properties in his name not mine. What happens to the properties are they part of the fund and who has to pay out the loans.His family will not let me access any paperwork so I can’t see how the loans were set up and his will has disappeared.
    There was also an outstanding bill with the tax office for the fund, who pays this bill.Any advice would be appreciated as I am at a loss to know what to do.
    Thank you
    Jennifer Stafford

  • Brock Chewings

    September 17, 2012 at 12:04 pm

    yu for such an informative post. This will really helps you to have a
    knowledge in SMSF.

Comments are closed.

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