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Scenario is as follow
Three families have their own individual SMSF super fund now . Now these super funds like to combine and want to buy a real estate worth 1.5 million (14 acre property with a house) with a LRBA loan of 500K.
Question 1 . What is the structure to get a LRBA loan for all three super funds.
Question 2. There is a chance of subdivison of land in future and is there any issues ?
Hello Antony
At a practical level, the three families in your scenario might find it difficult to find a bank who will lend to the respective SMSFs under limited recourse borrowing arrangements (LRBAs).
That said, it is certainly possible for three SMSFs to acquire an interest in real estate as tenants in common, with their respective interests partially funded by a borrowing, that meets the requirements of section 67A of the SIS Act.
Each SMSF will need to have a holding trust arrangement in place, sometimes referred to as a bare trust, where the legal title to the real estate is held on behalf of the trustee of the super fund.
ATO ID 2010/172 highlights a problem that can be encountered when SMSFs acquire an interest in real estate as tenants in common (50% interest each in the ATO ID), and rather than each SMSF having a holding trust with respect to its 50% share, there is only one holding trust agreement in place for both SMSFs, with each SMSF having an equal interest in asset held by holding trust. The ATO ID has confirmed that such arrangements fail to meet the requirements of section 67A.
Link to ATO ID 2010/172: https://www.ato.gov.au/law/view/document?src=hs&pit=99991231235958&arc=false&start=1&pageSize=10&total=35&num=0&docid=AID%2FAID2010172%2F00001&dc=false&stype=find&tm=phrase-basic-ATO%20ID%202010%2F172
It will also be important to ensure that in relation to each SMSF's borrowing, that should one of the SMSF's default in relation to their loan, that the only recourse the lender has in relation to the defaulting SMSF, is its 1/3 interest in the real estate. It is crucial that the lender's recourse is strictly limited to the borrower's 1/3 interest in the real estate.
For example, SMSF#1 defaults. The lender to SMSF#1 can dispose of only SMSF#1's interest in the real estate. If the value of a 1/3 interest in the real estate is insufficient to pay back SMSF#1's loan balance, the interests held by SMSF#2 and SMSF#3 are not able to be touched.
In relation to Question 2, there are some real problems with a subdivision of land that is acquired by a super fund using a LRBA (whilst the LRBA is in existence). The problem is that the asset acquired by the LRBA needs to remain the same "single acquirable asset" whilst the LRBA is in existence.
The ATO has confirmed in SMSFR 2012/1 at paragraph 35, that subdividing a block of land that is initially on one title, would cause the asset to cease being the original single acquirable asset.
Similarly, building on any portion of the 14 acres would not be permitted so long as the LRBA was in place.
Link to SMSFR 2021/1: Docid=SFR/SMSFR20121/NAT/ATO/00001
An alternative approach might be for the three SMSFs to invest in a geared unit trust, with each SMSF owning one-third of the units. Assuming the three families are not related to each other and that each SMSF only has a one-third interest in the unit trust, the investment should constitute an investment in an unrelated party. This assumption would need to be revisited if members of the three different families were carrying on business or income earning activities together.
A geared unit trust that is not a related party, would be capable of subdividing the property or building on it.
It is theoretically possible for the SMSFs to invest in an unrelated unit trust using an LRBA to fund their purchase of the units. Here the gearing is outside the unit trust and is at the unit holder level. The unit trust could then purchase the 14 acres and subdivide. This might seem counter-intuitive given the single acquirable asset concern identified above. However, in this instance, the single acquirable asset funded by the LRBA is the parcel of units in the unit trust and not the underlying assets of the unit trust. Having said that, at a practical level, it will be very challenging to find an arm's length lender willing to lend to SMSFs under an LRBA to acquire units in a unit trust.
It would be interesting to hear from other auditors if they have encountered the geared unrelated unit trust arrangement that I have described, or if they are familiar with a financial institution that would be comfortable with LRBAs for SMSFs investing in real estate as tenants in common.
Thanks for the question.