The biggest practical effect of the SMSF residential borrowing ban is simple: most funds do not hold enough cash to buy a property on their own. A Money.com.au survey around the time the ban started found only 12 per cent of SMSF investors planned to buy residential property outright with existing fund cash.
Pooling is one answer. A unit trust lets several investors combine their money in one property-owning vehicle. Done properly, it can give an SMSF exposure to brand-new residential property and, in one structure, still allow borrowing. Done poorly, it creates serious compliance problems.
This is general information only. It is not personal financial or tax advice.
Why the structure matters: the in-house asset rules
An SMSF can only hold a limited amount, generally 5 per cent of the fund's value, in "in-house assets". These include investments in related trusts, meaning trusts the fund and its associates control. Whether a unit trust is related or unrelated decides almost everything about what it can do.
Option A: an unrelated unit trust
If the fund and its associates do not control the trust, it is generally unrelated, and the SMSF's investment is not an in-house asset. In practice that usually means the SMSF and its associates hold less than half the units and have no control over the trustee.
The key advantage: an unrelated unit trust can borrow against the property. It is not subject to the LRBA rules, because the fund itself is not borrowing. The trust can also fund construction, which opens up house-and-land and off-the-plan purchases.
A commonly suggested setup is three unrelated SMSFs each holding a third of the units, which leaves a margin of safety against any one fund being treated as controlling.
Things to plan for:
- Staying unrelated. New investors, extra unit purchases or changes in relationships can tip the balance.
- Exits. What happens if a member dies, loses capacity or separates, or if one fund simply wants out?
- Costs. The trust needs its own deed, trustee, tax return and administration.
- Fit. The investment still has to suit each fund's deed and investment strategy.
Option B: a non-geared related unit trust
A fund can also co-invest with its own members or family through a related unit trust, provided the trust meets the conditions in regulation 13.22C of the SIS Regulations. Among them, the trust cannot borrow, cannot have a charge over its assets, cannot acquire assets from related parties (other than business real property) and cannot run a business.
This lets a fund combine its cash with members' personal money to buy a property outright. But the conditions must be met continuously. If any one is breached, the exclusion is lost permanently, and the fund's units become in-house assets.
What doesn't work: a related trust that borrows
Since the ban, there has been more discussion about setting up a related unit trust that takes out the loan, with the SMSF investing in the trust. As SMSF technical specialists at Heffron have noted, the borrowing may not breach the LRBA rules, but it can create a significant in-house asset problem. If your fund controls the trust and the trust borrows, the investment will usually be capped at 5 per cent of the fund. Make sure anyone proposing a "unit trust structure" can explain clearly whether the trust is related or unrelated.
A worked example
Three unrelated SMSFs each invest $250,000 in a unit trust, giving it $750,000 of equity. The trust buys a pair of new townhouses for a total of $1.1 million including costs, borrowing $350,000. Each fund holds a third of the units and receives a third of the net income, which is then taxed in each fund at super rates.
These figures are illustrative only. Lender terms for unit trust borrowing vary, and the structure would need advice before anyone commits.
What to do next
- Get structuring advice first. An SMSF specialist accountant or lawyer should confirm whether a proposed trust is related or unrelated, and document why.
- Speak with a licensed broker about lender appetite for unit trust borrowing, which differs from standard investment lending.
- Assess the property on its own merits. EWC sources new properties and works alongside your advisers on the property and finance side. Book a free call or send questions through the contact page.
General information only, not personal financial advice. Speak with a licensed adviser before acting.