Repairs, maintenance and improvements
You can also use part of the money borrowed to make repairs to the asset or maintain it in an income producing form. What you cannot use borrowings for is to make “improvements” to the asset.
So what is a “repair”?
A “repair” in relation to an LRBA relates to fixing or making-good defects in or damage to the asset by replacing the broken part or fixing the existing part so that the asset operates as before. An example could be if you had a house and find that a leaking tap needs fixing by a plumber. This would generally be seen as a repair.
“Maintaining” or “improving”
“Maintaining” is any work done to prevent future defects, damage or deterioration of the asset, or in anticipation of having to do so. An example would be painting the walls of a house.
Maintenance and repairs don’t tend to alter the asset in any way; they just keep it going as it should. An improvement on the other hand is something that fundamentally changes the nature of the investment asset.
For example, say as before a house’s plumbing needed fixing, and as part of that a new hot water service was required. As the same hot water system that was used before is no longer manufactured, you buy a new, more modern hot water system.
While this may be an improvement to the house, the asset as a whole hasn’t been changed fundamentally. On the other hand if you build a substantial extension to the house, such as a second level, this has drastically changed the asset’s value and the nature of the house. This is an improvement, and it will result in contravention of the law.
Issues to consider before getting into an LRBA
While LRBAs can be used to purchase any permitted asset, this structure is particularly attractive to those who want to enter into property investment as part of their fund investment strategy.
But like any investment, just because you can does not always mean it is a good idea. An LRBA is a complex arrangement that could cost a lot of money to set up, so it shouldn’t be entered into lightly. You need to ask yourself if this is the best way to bring a property into your SMSF portfolio, and you should research the alternatives.
Consider also that if you are purchasing a property through an LRBA that you are committing a significant amount of the fund’s resources to a single investment asset. This may be fine, depending on your circumstances, but can also not be good if you want to diversify.
Also consider, for example, that if the property remains untenanted for a period of time you are losing money on the rental returns (while still having to repay the lender).
Also understand that the lender is not likely to allow you to borrow the full amount for the investment. Many lenders will only lend 50% to 60% (though some may go as high as 80%), so this will mean that you need existing funds in your SMSF to pay for the deposit.
TAX OFFICE SCRUTINISES LRBAs
LRBAs are under the Tax Office’s microscope. An expert report recommended that LRBAs should be scrapped, however the Turnbull government has not implemented such advice. As a compromise, it has publically stated that LRBAs will be under a three-year review. So make sure you seek advice if your investment strategy directs you down this path. The LRBA radar camera is out, so stay within the limits.