Capital Works Under SMSF Loans & What You Can't Fund

You can't use borrowed money in your SMSF to improve or renovate a property you've already purchased. That restriction applies whether you borrowed the funds under a Limited Recourse Borrowing Arrangement last year or you're looking at refinancing now.

The rules around what you can and can't do with SMSF loans exist because of how the legislation was written. When your fund borrows under an LRBA, the borrowed money must be used to acquire a single asset. Once that asset is acquired, the loan can't be used for anything else. That includes capital works, renovations, extensions, or any other improvement that changes the character of the asset.

Why Borrowed Funds Can't Cover Improvements

The borrowed money under an LRBA is tied to the acquisition of a specific asset. That asset has to remain the same asset throughout the life of the loan. If you use borrowed funds to extend a warehouse, add a second storey to a commercial building, or renovate an office fitout, you've changed the asset. The law doesn't permit that.

This isn't about whether the improvement adds value or whether it's a sensible investment decision. It's about the structure of the borrowing arrangement itself. The loan is secured against the asset held in the bare trust. If the asset changes, the arrangement may no longer meet the legislative requirements under sections 67A and 67B of the Superannuation Industry (Supervision) Act.

Consider a fund that acquires a small commercial warehouse through an LRBA. Twelve months later, the tenant requests a mezzanine level to increase storage capacity. The trustee can't draw down additional funds from the LRBA lender to pay for that work. If the fund wants to proceed, it has to use existing cash reserves in the fund or wait until the loan is repaid and the property is legally owned by the SMSF.

What Counts as an Improvement

An improvement is anything that changes the character or nature of the asset. That includes structural work, extensions, additions, significant fitouts, and renovations that go beyond maintenance. Replacing a roof with a different material, adding a car park, or converting part of a building to a different use would all be considered improvements.

Maintenance and repairs are different. Replacing a broken air conditioner with a comparable unit, fixing a leaking roof, or repainting to maintain the property's condition can generally be funded from the SMSF's own resources without affecting the LRBA. The distinction matters because maintenance preserves the asset in its current state, while improvements alter it.

The line between the two isn't always clear. If you're replacing something as part of routine upkeep, that's usually maintenance. If you're upgrading, extending, or adding something that wasn't there before, that's usually an improvement. The intent and the outcome both matter.

How to Fund Capital Works Without Breaching the Rules

If your SMSF holds a property under an LRBA and you want to carry out capital works, you have two options. You can use existing cash in the fund, or you can wait until the loan is fully repaid and the property is transferred into the SMSF's name.

Using fund cash means the trustees need to ensure the fund has sufficient liquidity to cover the works without affecting other obligations like pension payments or operating expenses. That might involve holding back rental income, making additional concessional or non-concessional contributions, or selling another asset. Each of those options has tax and compliance implications that should be reviewed with an SMSF specialist.

Waiting until the loan is repaid removes the restriction entirely. Once the property is legally owned by the SMSF and no longer held in a bare trust, the trustees can renovate, extend, or improve the property using fund resources without limitation. That approach works where the capital works aren't urgent and the fund's investment strategy can accommodate the delay.

Refinancing and the Same Asset Rule

If you refinance an existing LRBA, the new loan must relate to the same single asset that was acquired under the original arrangement. You can't add a drawdown facility for future improvements as part of the refinance. That would breach the same asset rule and could cause the entire arrangement to fail the legislative test.

Refinancing to a different lender, securing a lower rate, or switching from a variable to a fixed rate are all permitted as long as the loan amount doesn't exceed what's needed to pay out the original loan and cover reasonable refinancing costs like discharge fees and new loan establishment costs. Anything beyond that risks creating a new borrowing arrangement that doesn't comply with the rules.

This applies to both residential LRBAs entered into before the ban took effect in August and commercial property loans acquired at any time. The legislative framework is the same. If the property was acquired using borrowed funds under an LRBA, those borrowed funds remain tied to the original asset.

What Happens If You Get It Wrong

Using borrowed funds to improve an asset held under an LRBA can cause the arrangement to breach the SIS Act. If that happens, the loan may no longer qualify as a compliant LRBA. The consequences can include the asset being treated as an in-house asset, penalties for the trustees, and in some cases, the income from the property being taxed as non-arm's length income at the top marginal rate.

That outcome is disproportionate to the mistake, but the rules don't offer much flexibility. The ATO's position is that the borrowing arrangement either meets the legislative requirements or it doesn't. There's no partial compliance and no grace period to fix it after the fact.

If you're unsure whether a particular expense counts as an improvement or whether your refinancing structure will meet the same asset test, the time to get advice is before you proceed. Once the funds are drawn and the work is done, you can't reverse it.

Capital works restrictions under an LRBA limit what your super fund can do with borrowed money, but they don't stop you improving a property altogether. You just need to use fund cash or wait until the loan is cleared. If you're weighing up whether a property acquisition under an LRBA fits your fund's strategy, or if you're looking at refinancing an existing arrangement, call one of our team or book an appointment at a time that works for you.

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