Property investment is gradually becoming more popular with SMSF investors, and I am often asked whether SMSFs can purchase house and land packages. Not only would the SMSF hopefully achieve some long term capital gain, it would also be entitled to claim some depreciation on the new asset as it ages. I always clarify first whether my clients want to purchase a house and land package or purchase a vacant block of land and then build a house on it. What is the difference? It can make a huge difference in the SMSF world, especially when there are borrowings involved.
Purchase as a single acquirable asset
An SMSF can borrow money to purchase a house and land package as long as it is purchased together in the one transaction as a single acquirable asset where the asset is identified up front as vacant land with a completed house on it.
But if an SMSF purchased a block of land with borrowings and then later built a house on the land, this would not be allowed under the limited recourse borrowing arrangement (LRBA). The superannuation law does not allow the single acquirable asset, in this case the block of land, to be improved (by building a house on it) while the loan remains outstanding. There is a very good reason for this.
The borrowing rule is referred to as a limited recourse borrowing arrangement. It means the lender’s rights, on any default on the borrowing by the SMSF, are limited to the single asset acquired under the arrangement. This means, the lender does not have any claim over any of the SMSF’s other assets. The borrowing is quarantined to the single acquirable asset. The law is designed to protect the remaining assets within the SMSF in the event of its default.
So, if an SMSF borrows to purchase a block of land and later builds a house on the land, and then due to some unfortunate financial circumstances cannot repay the loan, the lender will take possession of the asset – which is now a property consisting of a house and land. The money that the SMSF spent building the house on the vacant land is lost as it cannot be recovered from the lender. To make matters worse, the SMSF has also contravened the LRBA and would be in trouble with the Tax Office.
Make sure the SMSF complies
The trustees of the SMSF must ensure that:
- they identify up front that the single acquirable asset is the land with a completed house on it
- the lender’s security on the borrowing is at all times over the land and the completed house
- the LRBA with the lender allows for multiple draw-downs for the deposit, progress payments and the final payment at settlement.
House and land packages can offer investment opportunities for SMSFs, but if they don’t comply with the law, the investment could end up being a costly mistake.
Monica Rule is an SMSF Specialist Adviser and the author of ‘SMSFs and Properties’. See www.monicarule.com.au. This article is for general education purposes only and does not consider the personal circumstances of any investor.