Understanding the bare trust and custodian structure

Limited Recourse Borrowing Arrangements for Commercial Property

A limited recourse borrowing arrangement allows your SMSF to borrow for commercial property using a bare trust structure where a custodian trustee holds legal title until the loan is repaid. The SMSF trustee holds the beneficial interest and controls the property throughout the term. Commercial property that qualifies as business real property under section 66 of the SIS Act is exempt from the LRBA changes that commenced on 10 August 2026, meaning these arrangements remain available without the restrictions now imposed on residential LRBAs.

The structure requires three distinct legal entities. The SMSF trustee enters the loan agreement with the lender and services the debt. A separate custodian trustee, typically a corporate trustee established solely for this purpose, holds legal title to the property under a bare trust deed. The lender's recourse is limited to the asset held in the bare trust, not the other assets of the SMSF. The property must be a single asset, meaning multiple titles cannot be acquired under one LRBA unless those properties are distinctly identifiable as a single asset with equal market value and bought and sold together.

Business Real Property Definition and Mixed Use

Business real property means land and buildings used wholly and exclusively in one or more businesses. The actual use at the time of acquisition determines whether the property satisfies the definition, not how it is marketed or zoned. SMSFR 2009/1 provides detailed guidance on this assessment.

Consider a solicitor whose SMSF purchases a commercial office building leased to the solicitor's legal practice. If the building is used wholly and exclusively for the business of providing legal services, it qualifies as business real property. A property with a residential component on the same title may not qualify, or may only partially qualify, depending on the specific circumstances. The primary production concession under which a dwelling occupying no more than 2 hectares does not cause the property to fail the wholly and exclusively test applies only to primary production property, not to general commercial premises. A property with both office space and a caretaker's apartment would require careful assessment against the definition, and in most cases the residential component would prevent the property from qualifying in full.

Related Party Leasing and Arm's Length Terms

Business real property held by an SMSF and leased to a related party of the fund is excluded from the in-house asset rules. The lease must be made on arm's length terms at market value. A solicitor whose SMSF purchases the premises occupied by the solicitor's practice can lease the property back to the practice, provided the lease terms reflect what unrelated parties would agree to in the open market.

In a scenario where an SMSF purchases a commercial office for $950,000 and leases it to the member's legal practice, the rent must be set at the rate a tenant would pay for equivalent premises in the local market. The lease should document rent reviews, outgoings, maintenance obligations, and other standard commercial terms. The ATO scrutinises related party leases, and a rent set below market value may result in the arrangement being treated as providing a present-day benefit to the member or their business, which would contravene the sole purpose test under section 62 of the SIS Act. A formal independent valuation of market rent at the commencement of the lease and at each review period provides evidence that the arrangement is conducted at arm's length.

Restrictions on Improvements and Drawdowns

Borrowed funds under an LRBA cannot be used to improve an existing asset, and an existing SMSF asset cannot be placed into an LRBA. For LRBAs entered into on or after 7 July 2010, drawdowns for capital improvements are not permitted. The loan must be drawn down in full at settlement or structured with a single drawdown facility for the purchase price.

A solicitor whose SMSF purchased commercial premises under an LRBA cannot draw additional funds from the lender to fit out the property or make structural improvements. The SMSF can fund improvements from its own cash reserves or rental income, but not from the borrowing. Repairs and maintenance that do not improve the asset beyond its original state are permitted and do not breach the restriction, but determining what constitutes an improvement versus a repair requires careful assessment. Replacing a damaged roof with an equivalent roof is a repair. Extending the building or adding a new structure is an improvement and must be funded from the SMSF's own resources, not from borrowed funds.

Custodian Trustee and Bare Trust Deed Structure

The custodian trustee holds legal title to the property under a bare trust deed that defines the relationship between the custodian and the SMSF trustee. The custodian has no active duties beyond holding title and acting on the directions of the SMSF trustee. The bare trust deed must be drafted to comply with SIS regulations and to ensure the SMSF trustee retains beneficial ownership and control.

A corporate trustee is typically established as the custodian for each LRBA. The company acts as trustee of the bare trust and holds the property on behalf of the SMSF. The SMSF trustee makes all decisions regarding the property, including whether to lease it, to whom, and on what terms. The custodian executes documents at the direction of the SMSF trustee but does not exercise independent discretion. The bare trust deed should specify that the custodian must transfer legal title to the SMSF trustee once the loan is repaid in full. Until that transfer occurs, the property remains held in the bare trust structure and cannot be dealt with by the SMSF trustee directly.

SMSF Commercial Loan LVR and Application Process

Lenders typically offer SMSF commercial loans at an LVR of up to 70%, though some lenders may extend to 80% depending on the property and the SMSF's financial position. The loan application requires financial statements for the SMSF, details of the property, evidence that it qualifies as business real property, and a valuation. If the property will be leased to a related party, the lender will require details of the proposed lease and evidence that the rent is at market value.

In our experience, lenders assess the SMSF's capacity to service the loan based on the rental income the property will generate, the SMSF's existing cash flow from contributions and other investments, and the fund's overall financial position. A solicitor whose SMSF has limited cash reserves and relies on rental income from a related party lease must provide a lease agreement that demonstrates the rent is sufficient to service the debt. The lender may also require personal guarantees from SMSF members, though such guarantees must be limited in scope to comply with the limited recourse nature of the borrowing. Comparing SMSF commercial lenders before proceeding with an application ensures the structure meets both compliance requirements and commercial objectives.

Tax Treatment of Rental Income and Capital Gains

Rental income received by the SMSF from commercial property is taxed at 15% in the accumulation phase or 0% in pension phase, subject to the fund's status at the time the income is derived. Capital gains on the disposal of commercial property held for more than 12 months receive a one-third discount in the accumulation phase, resulting in an effective CGT rate of 10%. In pension phase, capital gains are tax-free.

A solicitor whose SMSF purchased commercial premises under an LRBA and leased the property to the solicitor's practice for 10 years before selling would pay CGT at 10% on the gain if the fund is in accumulation phase, or no CGT if the fund has moved to pension phase before the sale. The cost base includes the purchase price, stamp duty, legal costs, and other acquisition costs, but does not include the interest paid on the loan or ongoing holding costs such as rates and insurance, which are deductible in the year they are incurred. Rental income received during the holding period is taxed at 15% and offsets the interest expense and other deductible costs. The interaction between debt recycling strategies and SMSF structures is beyond the scope of this article, but warrants separate advice where personal borrowings are also in place.

Call one of our team or book an appointment at a time that works for you to discuss how a commercial LRBA structure applies to your circumstances and which lenders are suitable for your fund's acquisition.

Frequently Asked Questions