LRBA Ban : What does the proposed change mean for SMSFs?

The Government announced earlier this week that in future, SMSFs would be banned from using limited recourse borrowing arrangements (LRBAs) to buy residential property. This was part of a deal done with the Greens to ensure the Senate would pass the Government’s Budget measures (changes to capital gains tax, negative gearing etc).

Obviously this is bad news for those about to embark on a borrowing – so what exactly is happening and how will it impact SMSFs?

What is changing?

In all super funds, the starting position is that super funds can’t borrow.

The only reason LRBAs even exist is that they’re a specific exception to this general rule that was introduced in 2007. (And I should note – it’s an exception that applies to all super funds, not just SMSFs. SMSFs just tend to use the exception differently.)

This particular exception only allows borrowing to occur if the arrangement meets a number of strict conditions – including that the borrowed money is used to buy a single “acquirable asset”. Until now, the term acquirable asset has been broad enough to buy pretty much anything a super fund could normally invest in. In practice, constraints presented by the addition of the word “single” has meant that in practice, most borrowings related to property.

What will change under the proposed amendment is an extra condition will be added – if the single acquirable asset is real property, then it must be “business real property” (which is a defined term for super purposes).

When will the LRBA ban start?

It will only apply (commence) from the 45th day after the whole Bill is passed and receives Royal Assent (so won’t catch acquisitions occurring right now or acquisitions that have happened in the past).

It specifically doesn’t stop people refinancing existing LRBAs over residential properties or acquisitions where contracts had already been exchanged before commencement (even if settlement doesn’t occur until after the new law is in place). 

What does it mean?

This isn’t just a ban on LRBAs for residential property, it’s a ban on LRBAs for any real property that’s not business real property.

And remember some property that feels like commercial property falls short of being business real property. For example, a mixed use property such as a shop with a residential flat upstairs, isn’t business real property. One of the requirements for business real property is that it’s used “wholly and solely” in the business with some modest exceptions.

Paradoxically, sometimes residential property is business real property for a time but not forever. For example, someone who is running a business renting out investment properties can argue – if the scale of the operation is large enough and it meets other “business” tests – that a house is “stock” in that commercial enterprise and therefore business real property. Occasionally people use this argument to allow them to transfer an existing investment property into their SMSF (as SMSFs can acquire business real property from members and related parties but not other property).

But once it’s in the fund, if it’s no longer part of the business enterprise it presumably stops being business real property. I imagine that means even this arrangement is ruled out in future but we’ll have to see. Interestingly if you applied a genuinely “point in time” test to an arrangement like this (ie, exactly what is being bought by the SMSF when it takes out the loan?) it would be hard to argue that it’s business real property for the acquisition rules but not the borrowing rules. That said, I suspect very few people will be able to take advantage of it in any case.

For most people, that means buying residential property with a loan in their SMSF will no longer be an option.

It won’t matter whether the residential property is a new build or established property. While these are treated differently for some of the Government’s other changes (negative gearing, for instance, will still be allowed for new builds just not existing properties), there’s no distinction in the LRBA ban.

What’s still allowed?

SMSFs can still buy residential property without a loan.

If they want to borrow, they can still buy other things under an LRBA:

• Commercial property that meets the business real property definition
• Shares or units in managed investments – as long as it treats the whole holding as a single indivisible investment (ie, the SMSF couldn’t sell part of the holding while the LRBA was in place)

Will it really happen?

I suspect so. The Government needs the votes of the Greens to get its Budget legislation through the Senate and they’ve made this concession to achieve that. Unless something really blows up, I expect it’s a matter of time.

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