How an SMSF Property Loan Works: Structures, Responsibilities & Pitfalls

A Self-Managed Super Fund (SMSF) property loan is a specialised lending arrangement that allows an SMSF to borrow money to purchase certain types of property. Borrowing is only permitted under a strict structure known as a Limited Recourse Borrowing Arrangement (LRBA).

Under an LRBA:

• The SMSF borrows funds to buy a single acquirable asset (most commonly an investment property).
  
• The loan is secured only by that asset, not the entire SMSF.
  
• Other SMSF assets are protected if the loan cannot be repaid (subject to terms and conditions).

Because the rules around SMSF borrowing are tightly regulated, it’s important to understand the structure, responsibilities and risks involved.

How the LRBA Structure Works

An LRBA has several moving parts that must be set up correctly to comply with Australian superannuation law:

The SMSF Trustee

The SMSF trustee (individual or corporate) is responsible for:

• Making the borrowing decision
  
• Ensuring the investment aligns with the SMSF’s written investment strategy
  
• Ensuring the fund complies with the sole purpose test (retirement benefit only)

The Holding or Custodian Trust

The asset being purchased must be held in a separate holding trust until the loan is repaid.
This trust is sometimes known as:

• A bare trust
  
• A custodian trust

The holding trust owns the property legally, but the SMSF is the ultimate beneficiary.

The Property

The asset must be a single acquirable asset, such as:

• Residential investment property (not lived in by fund members or related parties)
  
• Commercial property (may be leased to a related party at market rates)
  
• Some industrial or specialised real estate (depending on lender policy)

The Lender

Lenders offering SMSF loans typically require:

• A larger deposit than standard home loans
  
• Evidence of the SMSF’s liquidity
  
• A compliant trust deed
  
• A clearly documented investment strategy

Lender requirements differ, and additional valuations or legal documents may be necessary.

Repairs vs Improvements: Understanding What’s Allowed

One of the biggest areas of confusion for trustees is what you can (and cannot) do after borrowing.

Repairs & Maintenance (Allowed)

Repairs can fix existing damage or wear and tear, such as:

• Painting
  
• Replacing broken fixtures
  
• Restoring a roof
  
• Updating plumbing or electrical systems

These do not change the property’s fundamental character.

Improvements (Limited Restrictions Under Borrowing)

Improvements that “maintain the character” may be allowed if funded from SMSF cash, not borrowed money.

Renovations That Change the Property (Not Allowed Under Borrowing)

Borrowed funds cannot be used for renovations that create a new asset or significantly alter structure, such as:

• Adding new rooms
  
• Major extensions
  
• Knocking down and rebuilding

These rules aim to prevent SMSFs from using borrowed funds for property development.

Trustee Responsibilities

Managing an SMSF loan involves significant obligations:

Compliance

Trustees must ensure:

• The SMSF trust deed allows borrowing
  
• The investment aligns with the SMSF’s investment strategy
  
• The property meets superannuation law requirements
  
• The sole purpose test is satisfied

Cash Flow Management

The SMSF must maintain sufficient liquidity to cover:

• Loan repayments
  
• Property management costs
  
• Insurance
  
• SMSF operating expenses
  
• Minimum pension payments (if applicable)

Record-Keeping & Reporting

SMSFs must maintain accurate and detailed records for:

• Loan contracts
  
• Bare trust agreements
  
• Financial statements
  
• Annual audits
  
• Compliance documentation

Insurance

Properties held within SMSFs typically must be insured appropriately, and insurance should be held in the correct legal name.

Common Pitfalls Trustees Should Watch For

Borrowing through an SMSF can increase investment capacity, but it can also introduce risks. Common pitfalls include:

Insufficient Liquidity

Lenders and auditors expect SMSFs to maintain appropriate cash reserves. A fund that becomes too heavily geared may struggle to meet its ongoing obligations.

Purchasing Ineligible Property

Related-party transactions, lifestyle properties, or assets used personally by members can breach superannuation laws.

Incorrect Structuring

Mistakes with the holding trust, trustee structure or loan documentation can cause non-compliance and costly legal issues.

Over-reliance on Rental Income

If the property becomes vacant or market conditions change, the SMSF must still meet its repayment obligations.

Unexpected Costs

SMSF loans may include:

• Higher establishment costs
  
• Ongoing fees
  
• Additional legal documentation
  
• Higher deposit requirements

These should all be reviewed before proceeding.

SMSF property loans can be a powerful tool for some trustees, but they come with strict rules, significant responsibilities and potential risks. Before deciding whether an SMSF loan is appropriate for your fund:

• Review your SMSF’s investment strategy
  
• Understand the responsibilities involved
  
• Seek specialised, independent advice
  
• Ensure compliance with superannuation law

Borrowing through an SMSF should always be considered carefully and with full awareness of the long-term implications. General SMSF lending information from BrokerCo.