Self-Managed Super Fund (SMSF) financing involves using the superannuation savings held within an SMSF to purchase investment assets, such as property.
One of the common structures used for financing these investments is through a Limited Recourse Borrowing Arrangement (LRBA). Here's an overview of how SMSF financing works, particularly focusing on the LRBA structure and the types of finance allowed and disallowed.
The overall process of financing SMSF assets at Hejaz is not too dissimilar to the standard property finance process.
What is SMSF Financing?
SMSF financing refers to the process of borrowing funds to invest in assets, typically property, while using the SMSF's existing funds to make a deposit. The borrowed funds must be used in compliance with superannuation laws, and the investments must align with the SMSF’s investment strategy.
Limited Recourse Borrowing Arrangement (LRBA)
An LRBA is a specific borrowing structure allowed under Australian superannuation law, where an SMSF can borrow money to purchase a single acquirable asset, such as real estate or shares. The "limited recourse" nature means that if the loan defaults, the lender’s claim is limited only to the specific asset purchased with the loan, and they cannot pursue the SMSF’s other assets.
Key Features of LRBA:
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Single Asset or Collection of Identical Assets: The borrowed funds must be used to acquire a single asset or a collection of identical assets that have the same market value. In the case of Hejaz, we only finance property assets for SMSFs.
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Separate Holding Trust: The purchased asset is held in a separate "bare trust" (also known as a holding trust) until the finance facility is repaid in full. This ensures the asset is isolated from other SMSF assets.
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Limited Recourse: If the finance facility defaults, Hejaz can only claim the asset held in the bare trust, not other assets of the SMSF.
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Repayment: The SMSF is responsible for repaying the loan through rental income, dividends, or other earnings, and the fund must have enough liquidity (cash) to service the loan.
Types of Finance Allowed for SMSF Certain types of finance and investments are allowed under SMSF rules, but strict regulations apply to ensure compliance with the law and the SMSF's investment strategy.
6 Summary of SMSF Financing and LRBA Structure:
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LRBA Structure: A limited recourse borrowing arrangement allows SMSFs to borrow money to acquire assets, with recourse limited to the specific asset purchased.
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Allowed Investments: Includes residential and commercial property, shares, and securities, if they meet the sole purpose test and the single acquirable asset rule.
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Disallowed Investments: Personal-use assets, such as homes for members or family, and loans for improving properties are not allowed.
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Compliance: The SMSF must remain compliant with superannuation law, ensuring liquidity, alignment with the investment strategy, and adherence to the sole purpose test.
By using an LRBA, SMSFs can leverage their funds to invest in growth assets like property, but they must carefully manage risks and ensure they remain compliant with strict superannuation regulations.