Unlock the Secrets to SMSF Loans in Pension Phase

Moving your SMSF from accumulation to pension phase changes how your fund's investment income is taxed, but it doesn't automatically wipe out tax on every property you hold.

For self-employed business owners who've used super to buy commercial or residential property, the transition to pension phase is often framed as a tax-free finish line. The reality is more conditional. Whether your SMSF property gains a full exemption, a partial exemption, or continues to be taxed depends on how your fund's assets are structured, when you bought the property, and whether you're drawing down all your super as a pension or keeping some in accumulation.

What Happens to Your SMSF Loan When You Start a Pension

Your Limited Recourse Borrowing Arrangement doesn't disappear when you transition to pension phase. The loan continues under the same terms, the holding trust remains in place, and your repayment obligations don't change. What does change is the tax treatment of rental income and capital gains generated by the property securing that loan, provided the asset supports a retirement phase income stream and your fund meets minimum pension payment requirements.

Consider a business owner who financed a commercial premises through their SMSF several years ago and has now turned 65. The loan balance sits at around 40 per cent of the property's current value, rental income covers the repayments, and the member wants to start drawing a pension. The loan itself isn't affected by the phase change, but the fund's ability to claim an exemption on rental income and future capital gains depends on whether the property is classified as a segregated current pension asset or whether the fund uses the proportionate method to calculate exempt current pension income.

How SMSF Property Gains Are Taxed in Pension Phase

A capital gain on an SMSF property is not automatically exempt because a pension has started. The exemption applies to investment income from assets that support a retirement phase income stream, and a capital gain falls within that definition only if the asset is either fully segregated to support the pension or the fund applies an actuarial proportion to its total assessable income.

Under the segregated method, income from segregated current pension assets is exempt and capital gains on those assets are disregarded entirely. A capital loss on a segregated asset cannot be offset against other gains. Assets cannot be segregated to the extent their market value exceeds the account balances of the income streams they support. From the 2022 financial year, where all of a fund's assets are paying retirement phase benefits at all times during the year, the segregated method must be used for the whole year and an actuarial certificate is not required.

Under the proportionate method, an actuary determines the exempt proportion, which is applied to the fund's total assessable income including any net capital gain, and an actuarial certificate is required each year. Where a fund has both accumulation and pension interests, the exemption is partial. If you're keeping some super in accumulation while drawing a pension from the rest, your fund will not qualify for full segregation, and the taxable portion of any gain will reflect the split between the two phases.

The Division 296 Tax and What It Means for Large Balances

From 1 July 2026, Division 296 tax applies to members with a total super balance above the large super balance threshold. For 2026-27, that threshold is $3 million, and a very large super balance threshold of $10 million also applies. Tax of 15 per cent applies to the proportion of a member's total super earnings that relates to the part of their balance above $3 million, and an additional 10 per cent applies to the proportion above $10 million.

Division 296 tax is assessed to the individual, not the fund, and can generally be paid from the member's super account. For an SMSF, Division 296 fund earnings are an adjusted amount of the fund's taxable income, and a portion is attributed to each in-scope member as relevant super earnings. Importantly, amounts owing under an LRBA are never included in a member's total super balance for Division 296 purposes, which means the outstanding loan balance is excluded from the calculation.

An SMSF can elect to adjust the cost base of its capital gains tax assets to market value at the end of 30 June 2026 for the purpose of working out Division 296 fund earnings. The election applies to all assets held by the SMSF at that time, including property held through an LRBA trust. Under the election, the first element of the cost base becomes the 30 June 2026 market value and each other element is taken to be nil. The election must be made by the due date of the SMSF annual return for 2026-27 and cannot be revoked. It does not need to be provided to the ATO, but records must be kept for five years.

For a business owner with a large balance who has held a commercial property in their SMSF for many years, the election can reset the cost base to reflect the current value rather than the original purchase price, which may reduce the assessable gain when the property is eventually sold. The trade-off is that the election is irrevocable and applies to all assets, not selectively.

SMSF Borrowing Rules After 10 August 2026

For any LRBA entered into on or after 10 August 2026, the real property being financed must be business real property when the loan is entered into and throughout the life of the arrangement. Business real property generally means land and buildings used wholly and exclusively in one or more businesses. Residential real property that meets that definition can still be acquired and financed under an LRBA, but it must qualify as business real property when the loan is set up and for the entire term.

If you entered into an LRBA before 10 August 2026 to finance a residential investment property that is not business real property, the new rule does not apply. You can maintain or refinance that loan on or after 10 August 2026 without needing the property to be business real property. The transitional protection also covers situations where you exchanged a binding contract to acquire real property before 10 August 2026, even if the contract settles or the LRBA is entered into after that date.

For business owners looking to use their SMSF to acquire commercial property, the path remains open. The property must be used wholly and exclusively in one or more businesses, and if it stops being business real property during the LRBA, the SMSF fails to maintain the arrangement under the rules and compliance action may apply. A commercial description alone does not make a property business real property. The actual use determines whether it qualifies.

What Self-Employed Buyers Should Know About Total Super Balance

For purposes other than Division 296 tax, a member's share of the outstanding LRBA balance is included in their total super balance if the LRBA was entered into on or after 1 July 2018 and either the lender is a related party or the member has met a condition of release with no cashing restriction, such as retirement, terminal medical condition, permanent incapacity, or being 65 years old. Some LRBAs entered into before 1 July 2018 and refinanced on or after that date are also included, unless the new borrowing is secured by the same asset and the refinanced amount is the same or less than the existing balance.

Your total super balance affects your eligibility to make non-concessional contributions and your transfer balance cap. From 1 July 2026, the general transfer balance cap is $2.1 million, and a person starting a pension for the first time on or after that date has a personal cap of $2.1 million. Where your total super balance on 30 June of the previous financial year was below $1.84 million, you can contribute up to $390,000 over three years under the non-concessional bring-forward arrangement. Where the balance was $1.84 million or above but less than $1.97 million, the limit is $260,000 over two years. Where the balance was equal to or more than $2.1 million, the non-concessional contributions cap is nil.

If you're in pension phase and your LRBA balance is included in your total super balance calculation, that can push your balance above the thresholds and affect your ability to make further contributions or transfer additional amounts into pension phase. Planning around these limits is particularly relevant for self-employed business owners who may have variable income and want to maximise concessional and non-concessional contributions in high-earning years.

Transitioning to pension phase unlocks tax concessions on income and gains from SMSF property, but those concessions are conditional on how your fund is structured, the type of property you hold, and whether you meet the regulatory requirements for exempt current pension income. If you're self-employed and holding property through an SMSF loan, the phase change is a point where tax strategy, loan structure, and compliance requirements all intersect.

Call one of our team or book an appointment at a time that works for you. We work with self-employed business owners across Melbourne and Australia to structure SMSF loans and pension phase transitions in a way that fits your circumstances and keeps you on the right side of the rules.

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