Unlock the secrets to SMSF commercial bare trusts

Why the bare trust structure is mandatory for SMSF commercial property purchases

Every limited recourse borrowing arrangement for commercial property requires a bare trust, with the asset held by a custodian trustee until the loan is repaid. The structure is not optional. Section 67A of the Superannuation Industry (Supervision) Act 1995 requires that the acquirable asset be held on trust for the SMSF, separate from other fund assets, with the fund holding a beneficial interest only. The legal title remains with the custodian trustee until the final loan repayment, at which point title transfers to the SMSF trustee.

The custodian trustee is typically a corporate entity established solely to hold legal title for that specific acquisition. The SMSF trustee controls the custodian trustee through share ownership and directorship, but the two entities remain legally distinct. The loan contract sits between the lender and the SMSF trustee, secured by a charge over the beneficial interest. A second charge or mortgage is registered against the legal title held by the custodian trustee.

Consider a litigation practice looking to purchase a commercial office premises through its SMSF. The SMSF trustee, acting in its capacity as trustee of the fund, enters into the loan agreement with the lender. A custodian trustee company is incorporated, typically with the same directors as the SMSF trustee. The custodian trustee signs the contract of sale and takes legal title at settlement. The SMSF holds the beneficial interest, receives rental income, and services the loan from fund cash flow. Once the loan is repaid in full, the custodian trustee executes a transfer of title to the SMSF trustee, completing the acquisition.

How lenders assess loan applications under a bare trust structure

Lenders evaluate the SMSF's capacity to service the loan from its existing cash flow, contributions, and rental income. The assessment does not rely on recourse to the individual members' personal income or assets outside the fund. The loan is limited recourse, meaning the lender's recovery in default is restricted to the asset held in the bare trust and any other fund assets that may be charged as additional security, depending on the lending terms.

Most SMSF commercial lenders require a loan-to-value ratio below 70 per cent, with some willing to lend up to 75 per cent in specific circumstances. The deposit and settlement costs must come from existing fund cash or in-specie contributions that satisfy the contribution caps and superannuation law requirements. Borrowed funds cannot be used to cover any part of the deposit, stamp duty, or other acquisition costs beyond the purchase price financed by the loan.

Serviceability calculations focus on the fund's total income, including concessional and non-concessional contributions, investment returns, and any rental income from the property being acquired. If the property will be leased to a related party of the fund, lenders require evidence that the lease terms reflect arm's length market rent. In our experience, most lenders ask for a formal valuation or rental appraisal to confirm the market rate before approving the loan, particularly where the tenant is a related entity.

What qualifies as business real property under section 66 of the SIS Act

Business real property means land and buildings used wholly and exclusively in one or more businesses. The definition is critical because it determines whether the asset is exempt from the in-house asset rules and whether the SMSF can acquire the property from a related party. A property marketed as commercial or zoned for commercial use does not automatically satisfy the definition. The actual use at the time of acquisition is what matters.

SMSFR 2009/1 sets out the ATO's interpretation and provides detailed examples. A property leased to a business for use as offices, consulting rooms, warehouses, or retail premises will generally satisfy the definition. A property leased to a tenant who uses it for residential purposes, even if the property is commercially zoned, does not qualify. The business use does not need to be conducted by the SMSF itself. A property leased to an unrelated business or to a related party business will both qualify, provided the actual use is wholly and exclusively for business purposes.

In a scenario where a litigation practice leases office premises from its members' SMSF, the property qualifies as business real property if the premises are used wholly and exclusively for the legal practice. The lease must be at market rent, documented in writing, and complied with as if it were an unrelated transaction. The rent paid by the practice becomes assessable income in the fund, taxed at a maximum rate of 15 per cent, provided the fund remains in accumulation phase. If the property is later sold, any capital gain may qualify for a one-third CGT discount if held for more than 12 months, or full exemption if sold after the fund has moved into pension phase.

Related party leasing and the arm's length requirement

Leasing commercial property from an SMSF back to a business controlled by a fund member is permitted under the SIS Act, provided the property satisfies the business real property definition and the lease is on arm's length terms. Arm's length terms means market rent, documented lease agreement, and compliance with all lease conditions. The ATO applies substance over form. A lease signed at market rent but not paid, or paid inconsistently, will attract regulatory scrutiny and potential penalties.

The arm's length requirement extends beyond rent. Lease duration, rent review clauses, outgoings, maintenance obligations, and any make-good provisions must reflect what would be agreed between unrelated parties in the same circumstances. A formal lease prepared by a solicitor with property law experience is standard practice. Most SMSF auditors will request a copy of the signed lease and evidence of rent payments during the annual audit.

We regularly see litigation practices that lease their premises from the members' SMSF. The structure works well when the practice has stable cash flow, the members are comfortable with superannuation as a wealth accumulation vehicle, and the property meets the business real property definition. The rent paid by the practice is deductible to the practice and taxed at 15 per cent in the fund. The structure also removes the property from the members' personal balance sheets, which can be useful in asset protection planning, though this depends on the timing of the transfer and the specific circumstances.

Restrictions on property improvements and loan drawdowns

Borrowed funds under an LRBA cannot be used to improve the asset after acquisition. Section 67A requires that the asset acquired remains the same asset throughout the arrangement. Capital improvements funded by borrowed money would result in the acquisition of a different or improved asset, which contravenes the single acquirable asset rule. Improvements can only be funded from the SMSF's existing cash reserves or future contributions, not from additional loan drawdowns.

The restriction applies to any capital expenditure that enhances the property's value or changes its character. Repairs and maintenance that restore the property to its original condition are permissible and can be funded from the SMSF's cash flow. Replacing a roof, repainting, or fixing plumbing are repairs. Extending the building, adding a second storey, or subdividing the property are improvements. The line between repair and improvement is not always clear, and professional advice is necessary for any significant work.

An example: an SMSF acquires a warehouse under an LRBA. The SMSF trustee later decides to add a mezzanine level to increase rentable space. The cost of the mezzanine cannot be funded by drawing down additional loan funds under the existing LRBA. The SMSF must either fund the improvement from existing cash, wait until members make additional contributions, or defer the work until the loan is repaid. If the SMSF proceeds with the improvement using borrowed funds in contravention of section 67A, the arrangement risks being treated as a non-complying loan, with potential tax consequences for the entire fund.

Loan rates and fixed versus variable structures for SMSF commercial lending

SMSF commercial loan rates are priced above standard commercial property loans due to the limited recourse nature of the lending and the regulatory complexity involved. Lenders have no claim against the individual members in default, which increases credit risk. Rates are influenced by the loan-to-value ratio, the fund's balance and cash flow, the quality and location of the property, and whether the tenant is a related or unrelated party.

Fixed rate options are available for terms of one to five years, though not all SMSF commercial lenders offer fixed rates. Variable rate loans offer flexibility to make additional repayments or repay the loan in full without break costs. Fixed rate loans provide certainty over the interest cost during the fixed period, which can assist with long-term cash flow planning in the fund. The choice depends on the fund's cash flow, the members' risk tolerance, and the expected contributions over the loan term.

When comparing SMSF commercial lenders, it is worth reviewing not only the interest rate but also the loan establishment fees, valuation requirements, ongoing account keeping fees, and the lender's willingness to deal with related party leases. Some lenders will not lend where the property is leased to a related party. Others will, but apply stricter serviceability criteria or require a lower loan-to-value ratio. The application process typically takes four to eight weeks from initial submission to unconditional approval, depending on the lender's turnaround time and the complexity of the fund's structure.

The transfer of title on final loan repayment

Once the loan is repaid in full, the custodian trustee must transfer legal title to the SMSF trustee. The transfer is not automatic. The SMSF trustee requests the transfer, and the custodian trustee executes the necessary documents to effect the change of registered proprietor. In most states, this involves lodging a transfer of land with the relevant titles office, along with any applicable duty or fee.

Stamp duty on the transfer from custodian trustee to SMSF trustee is generally exempt or nominal, provided the transfer is made in accordance with the LRBA and no consideration changes hands beyond the discharge of the loan. Each state has different provisions, and it is prudent to confirm the duty position with a conveyancer or solicitor before proceeding with the transfer. The timing of the transfer is also relevant for the fund's annual audit and financial statements. The asset should be reclassified from beneficial interest to legal and beneficial ownership once the transfer is registered.

The custodian trustee entity is usually deregistered once the transfer is complete, though some SMSF trustees retain the company structure for future use. If the SMSF intends to make further property acquisitions under separate LRBAs, a new custodian trustee must be established for each acquisition. The same custodian trustee cannot hold multiple properties acquired under different LRBAs, unless those properties were acquired together as a single asset under the same arrangement.

Call one of our team or book an appointment at a time that works for you to discuss your SMSF commercial property acquisition and confirm that your structure satisfies the legislative requirements before settlement.

Frequently Asked Questions