Transition to retirement requirements

[speary]

If you have purchased a property in an smsf using a LRBA you CAN make improvements to the property.

You CANNOT use the excess funds that you have borrowed under this arrangement to make these improvements. You CANNOT borrow money from any source to fund the improvements.

You can use cash in the SMSF to pay for the improvements.

See links below:

http://www.qandamp.com.au/q-and-a/property
- Can I Renovate or Improve an SMSF property

Improvements

These are defined by the ATO as building works where the state or function of the asset is significantly altered for the better, through substantial alterations, or the addition of further substantial features to the asset. They may include renovating a kitchen, adding an extension or a pool. In this instance, the SMSF can only use existing funds to finance the improvements. These existing funds can be accumulated in the fund by building up cash from contributions or rent received. An SMSF cannot borrow to undertake improvements.

Finally, for properties that have been purchased using borrowings in an SMSF, the ATO will not allow improvements that result in a change to the underlying nature of the property while the loan is still outstanding. For example, you cannot establish a borrowing arrangement to purchase a single dwelling and subsequently use SMSF cash to convert it into a block of investment units ? at least not until the loan has been completely repaid and the borrowing arrangement has ended.

If you are thinking about property improvements through your SMSF, you should consider seeking professional advice from a qualified financial adviser.



I note the second paragraph which mentions you can not make improvements that result in a change to the underlying nature of the property while the loan is outstanding.

I read this as meaning no granny flats, no subdivision no conversions to flats. I don't think this is intended to mean that you can't put in a new kitchen or add a pergola as this in my opinion doesn't change the nature of the property. I think it would be extremely restrictive for improvements not to be allowed and it doesn't really follow the Sole Purpose test in that the property is mean to provide for your retirement, naturally you should be able to improve it to grow your wealth, while still maintaining the underlying nature of the property.

Would be interested in hearing your thoughts on this.

 

[lizzie]

Would be interested in hearing your thoughts on this.

Could well be right - but - in our personal situation, we don't need to make improvements - and may only consider them "after" the loan is paid off.

There is only one thing in life that scares me - and that's the ATO ... better not to make assumptions or push the boundaries

 

[sash]

Yep....the ATO guys have more powers than the Federal Police.

There is only one thing in life that scares me - and that's the ATO ... better not to make assumptions or push the boundaries

 

[Mr. Fabulous]

These are defined by the ATO as building works where the state or function of the asset is significantly altered for the better, through substantial alterations, or the addition of further substantial features to the asset. They may include renovating a kitchen, adding an extension or a pool.

See the section 'Improvements, Repairs and Maintenance' in the link below.

http://www.yoursmsf.com.au/resource...6-limited-recourse-borrowing-arrangement-lrba

Currently the ATO's view is an asset acquired under a LRBA entered into on or after 7 July 2010 could not be improved using funds from any source. Under the draft ruling a property can be improved, but only by using the SMSF cash reserves or similar and providing the improvement doesn't result in a different asset being created.

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Let's be perfectly clear here. In Lizzie's case, the asset does not exist in the SMSF previous to the borrowings. An LRBA has been used to purchase the property. Therefore, improvements cannot be made until such time as the LRBA is repaid.

 

[speary]

Yep, cool. So much conflicting information on the web. Certainly highlights the need to get professional situation specific advice.

Thanks Mr Fabulous

Cheers

 

[lizzie]

Definitely - that's why I'm waiting for my advisor to arrive home from his holidays for final clarification ... in about 3 hours ... but I did want to be armed with as much info as possible so that I am aware of our obligations and consequences before talking to him

 

[sash]

So what says your advisor!

Definitely - that's why I'm waiting for my advisor to arrive home from his holidays for final clarification ... in about 3 hours ... but I did want to be armed with as much info as possible so that I am aware of our obligations and consequences before talking to him

 

[lizzie]

He's given it his blessing ... after a chat he knows that I realise what the requirements and implications are, and that the property/business complies.

Had a look at the property and looks good - basic, clean and well set out ... only problem ... after some digging questions - that the agent passed onto the vendors - we are discovering that out of the "so called" management fee being paid to the current owners - they are repaying around 30% of it back out for expenses such as linen hire and ground maintenance.

Perhaps things they had agreed to do these things as part of the management (property own by consortium), but then outsourced themselves.

So, the figures implied as income are around 20% down on what was presented.

Not happy - told the agent the effect of reduced income from these "hidden" expenses, and asked if there were any other surprises.

Asked for a full detailed expenses listing for the last financial year - including all expenses - and written confirmation from their accountant that the figures are accurate.

Haven't heard back yet. I think the agent was as surprised as we were - because they were just going off the figures supplied too.

Still an ok deal - but does make one wonder what else is missing.

Regardless - not sure the next move - waiting for the agent - it has been a great learning exercise and opened our minds to alternatives to simply shares.

 

[perthguy]

See the section 'Improvements, Repairs and Maintenance' in the link below.

http://www.yoursmsf.com.au/resource...6-limited-recourse-borrowing-arrangement-lrba

Currently the ATO's view is an asset acquired under a LRBA entered into on or after 7 July 2010 could not be improved using funds from any source. Under the draft ruling a property can be improved, but only by using the SMSF cash reserves or similar and providing the improvement doesn't result in a different asset being created.

--------------

Let's be perfectly clear here. In Lizzie's case, the asset does not exist in the SMSF previous to the borrowings. An LRBA has been used to purchase the property. Therefore, improvements cannot be made until such time as the LRBA is repaid.

I'm not sure I agree with your reading of the linked text. To me it is saying improvements CAN be made using existing funds (NOT borrowed funds) provided the improvement doesn't result in a different asset being created.

So if I bought a house in my SMSF using a LRBA and did a cosmetic reno on the kitchen/bathroom using existing SMSF funds, this should be ok provided that the renovations don't "result in a different asset being created". i.e. at the start the asset is a 3x1 house and associated land and at the end the asset is a 3x1 house and associated land.

The example given in the final ruling (SMSFR 2012/1) is this:

"A residential house is acquired under an LRBA and is rented out for a number of years. As the area is now a real estate hot spot a decision is taken to renew the kitchen which, although functional, is significantly out of date and showing wear and tear. The design of the kitchen is improved and modern equivalent, rather than superior, materials and appliances are used. The changes made do not significantly improve the state or function of the asset as a whole."

It appears you can make improvements to an asset as long as you use existing funds (not borrowed funds) AND that the improvements don't result in the asset becoming a different asset.

"30. Subparagraph 67A(1)(a)(i) provides that borrowings under an LRBA cannot be used to fund improvements. However, money from other sources can be used to improve (or repair or maintain) a single acquirable asset. For example, accumulated funds held by the SMSF may be used to fund the improvements. However, any improvements must not result in the acquirable asset becoming a different asset."

I also note that SMSFR 2011/D1 is a draft and that SMSFR 2012/1 is the "Ruling".

http://law.ato.gov.au/atolaw/view.htm?locid='SFR/SMSFR20121/NAT/ATO'&PiT=99991231235958

So replacing the kitchen and bathroom using existing funds should be ok but adding another bedroom using existing funds might not be ok.

As mentioned above, this is a minefield and anyone considering any of the above should seek competent specialist advice.

 

[lizzie]

we are discovering that out of the "so called" management fee being paid to the current owners - they are repaying around 30% of it back out for expenses such as linen hire and ground maintenance.

...

So, the figures implied as income are around 20% down on what was presented.

And then the plot thickens (or thins) ... turns out the figure the agent gave me for linen was a monthly figure - not weekly as she said.

This means we're back in the ballpark

 

[lizzie]

Accountant is applying to ATO for a ruling ... he has found unlimited examples of the SMSF owning the premises that the "owner" runs a business from - but cannot find an example where the SMSF actually owns the business itself.

Stay posted.

Figures all add up - have BAS statements and P&L's for last 5 years - council has no issues ... a long, drawn out process doing the due diligence.

If nothing else - a great learning curve and mind opener

 

[lizzie]

Approved by ATO!

Didn't need a special ruling as all the guidelines are already in place - ie, no personal use, cannot draw salary, not employing family etc - just a written report from the ATO outlining the strict guidelines we were already aware of.

Now to bite the bullet