Limited Recourse Borrowing Arrangement (LRBA)

A self-managed super fund (SMSF) is able to borrow money under an arrangement to purchase a single asset, or a collection of identical assets. The acquirable asset is held on trust so that the SMSF trustee acquires a beneficial interest in the asset and has a right to acquire legal ownership of the asset by making one or more payments. Any recourse that the lender or any other party has under the LRBA against the SMSF trustee is limited to the single fund asset, including rights to income.

The ATO recently released a draft tax ruling (SMSFR 2011/D1) clarifying the rules applying to limited recourse borrowing arrangements. The draft ruling outlines the meaning of the following terms:

  • a single acquirable asset
  • Improvements, maintaining or repairing

A Single Acquirable asset (SAA)

Currently the ATO’s view is that a SMSF could only use a LRBA to purchase a single acquirable asset such as a property on a single title. This draft ruling states that a property that exists on multiple titles can satisfy the definition of Single Acquirable Asset, as long as its physical characteristics identify it as a single asset, and the titles are not able to be dealt with or sold separately.

Example 1 - two adjacent blocks of land

  1. As part of the SMSF's investment strategy, the trustees want to acquire two adjacent blocks of land under the one LRBA. The vendor will only sell the two blocks together, however, there are no physical or legal impediments to the two blocks of land being sold separately.
  2. The two blocks of land are not a single acquirable asset. As a result, the two blocks of land cannot be acquired under one LRBA. However, each block could be acquired under a separate LRBA.

Example 2 - a factory complex on more than one title

  1. An SMSF trustee wants to enter into an LRBA to acquire a factory. The entire factory covers three separate legal titles.
  2. The factory is a single acquirable asset and can be acquired under one LRBA.

Improvements, Repairs and Maintenance

Currently the ATO’s view is an asset acquired under a LRBA entered into on or after 7 July 2010 could not be improved using funds from any source. Under the draft ruling a property can be improved, but only by using the SMSF cash reserves or similar and providing the improvement doesn’t result in a different asset being created.

It is an important stipulation that funds borrowed can not be used for the improvement of the asset but can be used to repair or maintain the asset. If an asset is already owned by the SMSF, and thus not subject to Limited Recourse Borrowing Arrangements, then a borrowing to fund repairs and maintenance for that asset would not satisfy the requirements of the LRBA provision.

In determining the differences between what constitutes repairs or maintenance and whether it has been improved, will depend on the assets qualities and characteristics at the time when the asset was acquired under the LRBA.

# Repair or maintenance example Improvement example
1. A fire damages a part of the kitchen (cook top, benches, walls and ceiling). Restoration of the damaged part of the kitchen would constitute repair of what is a subsidiary part of the asset being the house and land. If the kitchen was also extended by extension of the house this extension would be an improvement.
2. The guttering on the house is replaced and the house is repainted. A fence is replaced. A fire alarm is installed to comply with new council requirements. This would be repair or maintenance. The addition of a new pool or a new garage would be an improvement.
3. A cyclone damages the roof of the house. Replacement of the roof in its entirety is a repair. The addition of a second storey to the house at the time of also replacing the roof would be an improvement.
A farm (on a single title) is the single acquirable asset under an LRBA. At the time of entering into the LRBA the farm includes one set of cattle yards, four bores including windmills, tanks and troughs and three kilometres of fencing.
4. Replacing a section of the cattle yards or the existing fencing is a repair. Ensuring the bores, windmills, tanks and troughs continue working is repair or maintenance. This would include laying new pipes between the tank and trough. Each of the following additions is an improvement: · a new set of cattle yards; · a new bore, tank, windmill and trough; · a dam; · a further two kilometres of fencing.

Consideration needs to be given to whether any improvements or other changes to an acquirable asset result in a different asset being held, the following is some examples:

# Single acquirable asset Whether it is a different asset(s)
1. Vacant block of land on single title The vacant block of land is subsequently subdivided resulting in multiple titles. One asset has been replaced by several different assets as a result of the subdivision.
2. Vacant block of land on single title A residential house is built on that vacant land (still single title). The character of the asset has fundamentally changed from vacant land to residential premises. This is a different asset.
3. A house and land The house is demolished and is replaced by three strata titled units. The character of the asset has fundamentally changed along with the underlying proprietary rights. This has created three different assets.
4. A house and land Rezoning of the land is granted and the house is renovated and is now commercial premises. The character of the asset has fundamentally changed from residential premises to commercial premises. This is a different asset.
5. A four bedroom house and land A fire destroys the four bedroom house and a four bedroom house is constructed using insurance proceeds. Rebuilding a four bedroom house does not fundamentally change the character of the asset held under the LRBA. Rebuilding the house restores the asset to a house and land.

If you have or are considering a purchase of this nature, we strongly recommend you seek professional advice.

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