Refinancing a limited recourse borrowing can result in significant interest savings but beware.
For reasons that I have never been able to understand, legislation has been in effect since 1 July 2018 that has resulted in certain limited recourse borrowings being included in a member’s total super balance for the purposes of determining contribution eligibility. As an aside, the previous proposed Div 296 legislation excluded LRBAs from the member’s total super balance for Div 296 purposes and we expect that to continue to be the case.
Where the borrowing is included, the effect is bizarre. Let’s assume that John is the sole member of an SMSF with a geared property. His member balance is $1.7m. This is backed by investments of $2.1m and a LRBA of $400k. He now intends to make a $360k non concessional contribution to apply to the reduction of the fund’s borrowing. If the loan balance was not included in his total super balance this would be fine but, as this loan satisfies the conditions to be included, his total super balance is $2.1m for contribution purposes so he can’t make the contribution. Effectively he is prevented from making the contribution by the loan balance which the contribution is intended to reduce.
When is a limited recourse borrowing treated this way?
Any existing borrowings that commenced prior to 1 July 2018 are excluded from this treatment.
Any that commenced from 1 July 2018 MAY be included. This will include any older loans that have been refinanced unless the new borrowing is secured by the same asset and the refinanced amount is not more than the old loan payout.
Borrowings that are not from a related party will only be included once a member has triggered a condition of release, such as retirement, terminal illness, permanent incapacity or being 65 years old. In this case their prorata share of the loan will be included.
Related party limited recourse borrowings are included, prorata across all members, irrespective of preservation status. Ridiculously this could result in a need to refinance a loan with an institutional lender just to enable the members to make non concessional contributions in the following year, when their total super balances will have been adjusted to reflect their actual member balances. Note that this would not assist if a member had triggered a condition of release as previously mentioned. For funds with such members, the loan could be reduced by selling assets or by non-concessional contributions from unaffected other members, neither of which might be preferred. Conceivably, another member could roll their balance into the fund, giving the trustees sufficient liquidity to repay the loan. That such matters even warrant consideration underlines the bureaucratic ridiculousness of this rule.
I will be speaking about this, and other LRBA tricks and traps, at the SMSF Association Annual Conference in February. I hope to see you there.
