After months of speculation, the Australian Taxation Office (ATO) has finally released its official ruling on borrowing inside of super, particularly in regards to property investments, providing investors with a clearer outline of the dos and don’ts of super gearing.
The ATO’s ruling on super gearing, formally known as a Limited Recourse Borrowing Arrangement (LRBA), specifically relates to self-managed super funds (SMSFs) and clarifies the details of the draft ruling that was issued in September 2011. You can recap that in my article New opportunities open for investing in property [1].
If you’ve already geared inside of super, or are thinking about such an investment, then you might like to read the official document, SMSFR 2012/2 [2].
The final ruling
So are there any significant differences between the final ruling and the draft? In truth, nothing earth shattering.
The ruling looks at LRBAs from the point of view of real estate investments, but notes that many of the issues raised might apply to other assets, such as plants and equipment.
LRBAs entail a super fund borrowing money to purchase an asset, which must be held in a special type of trust (often called a Holding Trust) while the loan remains outstanding. Further details about LRBAs can be found in Borrowing and lending with your SMSF.
Repairs, maintenance and improvements to assets
Under the new super laws, an asset in the Holding Trust can be ‘repaired and maintained’, but it can’t be ‘improved’ using borrowed money. In most cases – especially real estate – the asset can’t be replaced.
So what’s the difference between an improvement and repair?
An ‘improvement’ involves adding new or substantial features or rights to an asset that substantially increases the asset’s value or functional efficiency. So, for instance, an SMSF would generally want to steer clear of a ‘renovator’s delight’ because it would not be able to use borrowed funds to improve the property. Note: it’s a different kettle of fish if the SMSF doesn’t need to borrow funds; in such cases, it can use existing money to make improvements to a property.
On the other hand, ‘repairing’ an asset means the act of fixing defects, damage or deterioration, including the renewal of parts. A repair doesn’t imply a total reconstruction. The repair may result in an improvement to an asset, but only to a minor and incidental extent.
As mentioned, assets held through an LRBA should not be replaced. But in some cases, repairing an asset may involve replacing it. Therefore, you should seek specific advice to make sure you are taking the right course of action before you repair or improve any asset.
The situation can be summarised as follows:
[3]The differences between what constitutes a repair, maintenance, improvement or replacement can be highly complex. If in doubt, consider seeking good advice before proceeding.
Off the plan property purchases
An SMSF can use an LRBA to invest in a property ‘off the plan’, however, it can’t borrow to pay for the initial deposit – this deposit must be paid for using existing funds. Once construction of the property is complete and it has been strata titled, the super fund can complete the purchase using a super gearing arrangement.
Real estate with more than one title
Ordinarily, only a single acquirable asset can be purchased using an LRBA. (An exception to this is a group of ‘like’ assets, such as shares. In such cases, the assets in the Holding Trust must be the same and have the same value.)
This creates an obvious problem for property that involves more than one title. The ATO has now confirmed that a super fund can purchase real estate that involves more than one title only if the assets can’t be dealt with separately.
If a vendor wants to deal with assets as a package or the lender will only lend over a group of assets, but the assets can actually be dealt with separately, then this isn’t a permitted super gearing asset.
The bottom line
Some important points to note:
- the ruling only covers LRBAs put in place after 6 July 2010;
- make sure you get good advice regarding LRBAs from a lawyer who understands both super and property law very well. LRBAs involve a complex mix of trust law, property law, State and Federal tax laws and the super laws. You need someone on your side who is experienced in all these areas otherwise your documentation might be substandard.
Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Anyone should, before acting, consider the appropriateness of the information in regards to their objectives, financial situation and needs and, if necessary, seek professional advice.
Also in the Switzer Super Report
- Geoff Wilson: Why LICs are superior investments [4]
- Lance Lai: Chart of the week: a buying opportunity lies ahead [5]
- Rudi Filapek-Vandyck: The broker wrap: five more Buy ratings [6]
- Paul Rickard: Act now to save on private health cover [7]