Repairs and improvements on properties held by SMSFs

What happens when a property held by an SMSF needs repairs? Is it possible to use borrowed funds for renovations? Geoff Morris explains the rules…

Funds borrowed under the LRBA may be used for property repairs but not improvements.

Self-managed Superannuation Funds have always been able to invest in property. However until recently they were not able to borrow money to help finance that investment, and were also unable to use the property as a security for any loan.

The Act was changed several years ago to allow SMSF’s to enter into a Limited-Recourse Borrowing Arrangement (LRBA).

How LRBA funds can be used

The LRBA effectively allows the fund to borrow to assist in the purchase of a property.

One of the key concepts to understand if you are considering using an LRBA to fund an SMSF property purchase, is that money borrowed under the LRBA may only be used to repair or maintain the property, but never to improve it.

As per the Australian Taxation Office Ruling SMSFR 2012/1:

A repair restores the function of the asset without changing its character and may include restoration to its former appearance, form, state or condition. A repair merely replaces ‘a part’ of something that is already there and has become worn out, delapidated through ordinary wear and tear, or is damaged whether accidentally or deliberately or by natural causes.
An asset is improved if the state or function of the asset is significantly altered for the better, through substantial alterations, or the addition of further structural features or rights to the asset.

There is no set guide as to when an asset is repaired or improved, each case has to be considered on its own individual merits.

How to determine if a project is a repair

One example given by the Australian Taxation Office may help most people. The Australian Taxation Office considers the project in this example has been repaired:

A residential house is owned by an SMSF member on LRBA and is rented out. The kitchen is out of date and showing signs of wear and tear. The design of the kitchen is an improved and modern equivalent, rather than superior materials and appliances being used. The changes made do not significantly improve the state or function as a whole.

Monies held by the SMSF can be used for property improvements.

Making property improvements

Although borrowed funds can’t be used for property improvements, monies held by the super fund however may be used to improve an asset, as long as the improvements do not result in the property becoming a different asset.