The SMSF Professionals’ Association of Australia (SPAA) has today issued a fact sheet highlighting the risks to SMSF trustees of entering into a limited recourse borrowing arrangement.
SPAA Technical Director Peter Burgess says: “A gearing strategy can assist people grow their retirement savings, but there are significant risks that must be considered before embarking on this strategy; it’s very much a case of look before you leap.
“In particular, there has been a lot of discussion recently around limited recourse borrowing arrangements for SMSFs, and while they can offer benefits to fund members, a non-complying arrangement can have dire financial consequences for trustees if they are unaware of the pitfalls.”
In a comprehensive fact sheet, which is designed to be issued by SMSF practitioners to alert and educate their clients, Burgess detailed several key risks. They include:
- Only assets that the SMSF trustee is not otherwise prohibited from acquiring can be bought under a limited recourse borrowing arrangement. Although there are exceptions, this generally means that assets a trustee or a related party own cannot be bought under this arrangement.
- Assets acquired under this arrangement cannot generally be replaced with a different asset. In practice, this means alterations to a property cannot be made if it fundamentally changes the character of the asset.
- There may be additional costs associated with acquiring an asset under this arrangement.
- Loan repayments are deducted from a fund, meaning it must always have sufficient liquidity to meet repayments.
- The Australian Taxation Office has become aware that certain limited recourse borrowing arrangements have not been structured correctly. In these cases it’s not simply a matter of restructuring the arrangement. Rather, it has to be unwound, often at a substantial loss.
Burgess stresses there are benefits from these borrowing arrangements, such as giving trustees the opportunity to leverage their superannuation savings, tax concessions, and asset protection when bankruptcy occurs.
“Used in the right circumstances and structured correctly, there can be considerable benefits associated with these borrowing strategies. But SPAA is concerned that some people are seeing this type of borrowing as a way into a property investment without realising the potential downside.
“Many seminars and written articles have been devoted to explaining the benefits of these arrangements without necessarily pointing out all of the risks. It’s for this reason we issued the fact sheet which explains the key benefits as well as the key risks,” he says.