SMSF Borrowing — Limited Recourse Borrowing Arrangements (LRBA) Explained

Under normal superannuation law, funds cannot borrow money. SMSFs are an exception — they can borrow under a Limited Recourse Borrowing Arrangement (LRBA) to purchase an asset. LRBAs are most commonly used to purchase property, but they can also be used for other assets like shares.

The key feature of a limited recourse arrangement is that if the fund defaults on the loan, the lender’s recourse is limited to the asset purchased with the loan — the lender cannot pursue the fund’s other assets.

How an LRBA Works

An LRBA involves three key parties:

1. The SMSF — the borrower, which will eventually own the asset outright
2. The lender — a bank or related party providing the loan
3. The bare trust (holding trust) — a separate trust that holds the asset on behalf of the SMSF during the loan period

The structure works as follows:

1. The SMSF contributes the deposit and the lender provides the loan
2. The asset is purchased and held in the bare trust — not directly by the SMSF
3. The SMSF makes loan repayments from fund assets (contributions, rent, pension payments, etc.)
4. When the loan is fully repaid, the asset is transferred from the bare trust to the SMSF directly

During the loan period, the SMSF has the beneficial ownership of the asset (i.e. receives the income, such as rent) but legal title is held by the trustee of the bare trust.

What Assets Can Be Purchased via an LRBA?

An LRBA can be used to purchase a single acquirable asset — which generally means:

• Residential or commercial property
• ASX-listed shares (less common — most lenders don’t lend for SMSF share purchases via LRBA)
• Units in a unit trust
• Other assets permitted under the SIS Act

Key restriction: The SMSF cannot improve or alter the asset while it is held in the bare trust. This means:

• You can maintain the property (repairs, like-for-like replacements)
• You cannot improve it (renovations that increase the value) until the asset has been transferred to the SMSF (i.e. the loan is repaid)
• This rule has significant implications for property development strategies using an LRBA

ATO Safe Harbour Rules for LRBAs

Where the lender is a related party (e.g. the trustees lending to the SMSF from their own money, or a related family trust), the loan must meet the ATO’s safe harbour terms to be treated as arm’s length. The safe harbour sets the minimum interest rate and other conditions:

For real property (2025–26 safe harbour rate):

• Minimum interest rate: RBA Indicator Lending Rate for standard variable housing loans (typically 5–9%, check current ATO guidance)
• Loan-to-value ratio: Maximum 70% for residential, 65% for commercial
• Loan term: Maximum 15 years (residential), 15 years (commercial)
• Payments: Principal and interest

If the LRBA does not meet the safe harbour, the ATO may treat the arrangement as non-arm’s length income (NALI), which is taxed at 45% rather than 15%.

For bank loans: Commercial bank LRBAs don’t require safe harbour compliance because they are already arm’s length by nature.

LRBA Setup and Ongoing Costs

Setting up an LRBA involves professional and legal costs beyond a standard property purchase:

The additional complexity of an LRBA materially increases annual administration costs. The economics of an SMSF property purchase need to account for these ongoing professional costs.

Risks of LRBAs

Cash flow risk: The SMSF must meet loan repayments from fund cash flows (contributions, rent, investment income). If a member stops contributions or rental income drops (vacancy), the fund may struggle to service the debt.

Interest rate risk: Many SMSF loans are variable rate. Rate increases directly increase cash flow requirements.

Liquidity risk: A property-heavy SMSF with an LRBA may have very limited liquid assets. Members approaching retirement may find the fund cannot easily pay pensions or lump sum withdrawals without selling the property.

Market risk: If property values fall, the fund may be in negative equity. However, the limited recourse nature means the lender cannot pursue other fund assets — only the property — if the fund defaults.

Regulatory risk: LRBA rules have been subject to significant scrutiny and there have been calls from the financial services industry to restrict SMSF borrowing. Regulatory changes could affect the future viability of existing LRBAs.

Can a Related Party Be the Lender?

Yes — a related party (e.g. a family trust, another family member, or a company controlled by the trustees) can lend to the SMSF via an LRBA, provided the terms meet the ATO’s safe harbour rules. This can allow families to finance SMSF property purchases using their own capital rather than going to a bank.

Key compliance requirements for related-party LRBAs:

• Loan must be documented in a formal loan agreement
• Interest must be at the safe harbour rate (reviewed annually)
• Repayments must be made as scheduled
• The arrangement must be genuinely arm’s length in substance

Frequently Asked Questions

Can we buy residential property from a related party using an LRBA? No. The basic rule prohibiting acquisition of assets from related parties applies equally to LRBA purchases. You cannot buy a residential property from a related party (e.g. a family member’s investment property) and put it in your SMSF via an LRBA. This is a common misconception. Business real property is an exception (you can buy commercial property from a related party, subject to conditions).

Can the SMSF renovate the property while it’s in the bare trust? No — improvements (as distinct from maintenance) to the asset while it is in the bare trust are prohibited. Repairs and like-for-like replacements are permitted (e.g. replacing a broken hot water system with an equivalent one). Major renovations that materially improve the property must wait until the loan is repaid and the property is in the SMSF’s name directly.

What happens to the LRBA if a member dies? If a member dies while the SMSF has an LRBA, the fund must still continue to service the loan from its cash flows. If the fund cannot meet the loan obligations, it may need to sell the asset. This highlights the importance of adequate insurance (life, TPD) held inside or outside the SMSF to ensure liquidity on a member’s death.

LRBAs are complex and require careful legal and financial planning. For advice tailored to your situation, speak with a licensed SMSF specialist or registered tax agent. You can find one through the ASIC financial advisers register or MoneySmart.

See also: Self-Managed Super Funds.