Limited Recourse Borrowing Loan Agreement

A limited recourse borrowing loan agreement, also known as an LRBA, is an arrangement that allows self-managed super funds (SMSF) to borrow money to purchase a single asset, such as a property or shares. However, the lender only has limited recourse to the SMSF`s other assets if the loan defaults, hence the name.

An LRBA can be a useful strategy for SMSFs looking to diversify their investment portfolio or acquire a larger asset than they could purchase outright. However, it also carries certain risks and restrictions that need to be carefully considered.

Firstly, the asset acquired through an LRBA must be held in a separate trust, known as a bare trust. This trust is held in the name of the lender until the loan is repaid, at which point it is transferred to the SMSF. This means that the SMSF does not have legal ownership of the asset until the loan is fully paid.

Another significant consideration is the maximum amount that an SMSF can borrow for an LRBA. Generally, the loan cannot exceed 70% of the market value of the asset, and the SMSF must provide the remaining 30% as a deposit. Additionally, the SMSF must have enough cash flow to service the loan repayments, which can be a challenge for some funds.

One of the most significant benefits of an LRBA is the potential for tax advantages. If the asset purchased through the loan generates income, such as rent from a property or dividends from shares, that income is taxed at the SMSF`s concessional rate, which is usually lower than the individual tax rate. Additionally, the interest on the loan is tax-deductible for the SMSF, further reducing the tax liability.

However, it`s crucial to be aware of the potential risks associated with an LRBA. If the asset purchased through the loan does not perform as expected, or if the SMSF cannot make the loan repayments, the lender may be able to seize the asset held in the bare trust. In some cases, this could lead to the SMSF being forced to sell other assets to repay the loan, which can disrupt the fund`s investment strategy and result in significant financial losses.

Overall, an LRBA can be an effective strategy for SMSFs looking to diversify their investment portfolio and potentially generate tax advantages. However, it`s crucial to carefully consider the risks and restrictions involved and seek professional advice before entering into an LRBA.