An SMSF loan is legal when it is a Limited Recourse Borrowing Arrangement (LBRA).
An LBRA is a loan taken out by an SMSF trustee with a third party lender, to purchase a single asset (or collection of identical assets that have the same market value) that provides investment returns to the SMSF.
This type of SMSF loan is generally a long-term investment, to provide a market return, and is legal.
If the SMSF defaults on the LBRA, the third party lender’s rights are limited to recovering only that asset, so that the other assets owned by the SMSF remain protected.
Why do you need an LBRA for an SMSF loan?
When borrowing from an SMSF in Australia, trustees must organise an LBRA. If they do not, they are breaking the ATO superannuation laws. If an auditor reports that your SMSF has borrowed money without an LBRA, you may be ordered to sell the property and your fund could be made ‘non-complying’.
There are many costs involved with selling a property, and if you borrow money without such an arrangement, you may have to sell the property for less than the SMSF paid for it. This can also result in thousands of dollars in fines for the individual trustee who set up the illegal loan.
Borrowing money with an LBRA can work, but it’s crucial that you follow all the rules and speak with an SMSF professional before you sign anything.
You can learn more about limited recourse borrowing arrangements from the ATO.
When is a loan made by an SMSF legal?
If your SMSF is considering loaning money to an individual or business, it must be in the best interests of all fund members. It must also be for the sole purpose of generating a market return for members when they retire.
For instance, a business loan that charges interest over a 10-year period may qualify as a legal SMSF loan, as long as it matches the SMSF investment strategy and does not involve any related party.
If your fund is audited, and it is found that a loan arrangement is not in the best interests of the members of the SMSF, your fund may be labelled ‘non-complying’ by the ATO. This means the SMSF could lose up to half of its assets, and fund members could face serious penalties.
This is why it is best to speak to a financial adviser or an SMSF professional before you draft any loan arrangements on behalf of the SMSF.