The use of a limited recourse borrowing arrangement (LRBA) to acquire vacant land can result in significant compliance risk for SMSF trustees if their intention is to develop the asset in the future, a senior executive of an accounting firm has said.
“An LRBA is a very bad vehicle for purchasing vacant land where the trustee of the fund wants to build on that vacant land and the whole reason for this is the concept of a single acquirable asset,” LDB Group principal Michael Gilmour warned.
“[If] that single acquirable asset hypothetically is vacant land, so long as the borrowing is in existence, it is not able to change its characteristics or nature. So the moment you build on vacant land, you’ve fundamentally changed the characteristic of that vacant land,” he added.
He noted some trustees acknowledge this situation and attempt to address it by funding any building on the vacant land without using the proceeds of the LRBA, but this is not an acceptable solution.
“That actually doesn’t make the situation any better. It doesn’t actually matter that you’re not using the LRBA to fund the development. The fact that you’re using the fund’s other resources is irrelevant [because] you’ve still fundamentally changed the nature of the vacant land,” he pointed out.
According to Gilmour, SMSF trustees looking to use gearing to acquire vacant land and then develop it might be better off implementing the strategy through a unit trust.
“[You could] perhaps use an LRBA to fund the purchase of the units in a unit trust and then have the unit trust buy the vacant land and the unit trust then develop that vacant land because the single acquirable asset in that instance will be the units in the unit trust,” he said.
However, he suggested the strategy, while eliminating a compliance issue, could face practical challenges as it may prove very difficult to find a financial institution that will lend to a unit trust.
“So easier said than done,” he concluded.
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