Can an SMSF buy land and build?

author-avatar By on September 15, 2021
Can an SMSF buy land and build?

SMSFs can be complex beasts, so it’s no shock the rules around them buying land and building are the same.

If you’re looking at investment options for your SMSF, you might think building a home is a solid strategy. Find out if it can be done here, what to consider prior, and some alternative options.

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Looking to take control of your retirement? This table below features SMSF loans with some of the most competitive interest rates on the market.

Lender
Advertised rate Comparison rate Monthly repayment Rate TypeOffsetRedrawOngoing FeeUpfront FeesLVRLump Sum RepaymentAdditional RepaymentsPre-approval
VariableMore details
LIMITED TIME OFFER

Smart Booster Home Loan Discounted Variable - 2yr (LVR < 80%)

  • Fast turnaround times, can meet 30-day settlement
  • For purchase and refinance, min 20% deposit
  • No ongoing or monthly fees, add offset for 0.10%
LIMITED TIME OFFER

Smart Booster Home Loan Discounted Variable - 2yr (LVR < 80%)

  • Fast turnaround times, can meet 30-day settlement
  • For purchase and refinance, min 20% deposit
  • No ongoing or monthly fees, add offset for 0.10%
VariableMore details
WIN YOUR HOME LOAN INTEREST FREE

Nano Home Loans Variable Owner Occupied, Principal and Interest (Refinance Only)

  • WIN your home loan interest free and save up to $1.1 million. Refinance by 29 October. T&Cs apply.
  • Refinance Only. Fast online application, refinance in minutes, not weeks.
  • No Nano fees, Free 100% offset sub account. Mobile app. Visa debit card & instant payments.
WIN YOUR HOME LOAN INTEREST FREE

Nano Home Loans Variable Owner Occupied, Principal and Interest (Refinance Only)

  • WIN your home loan interest free and save up to $1.1 million. Refinance by 29 October. T&Cs apply.
  • Refinance Only. Fast online application, refinance in minutes, not weeks.
  • No Nano fees, Free 100% offset sub account. Mobile app. Visa debit card & instant payments.
VariableMore details
YOU COULD WIN $100k TO PAY DOWN YOUR LOAN*

Owner Occupier Accelerates - Celebrate (LVR < 60%) (Principal and Interest)

  • For a chance to win $100K towards your home loan, apply with Athena before Oct 31 & be approved by Dec 15
  • We lower your rate based off how much you’ve paid down your loan
  • Automatic rate match
YOU COULD WIN $100k TO PAY DOWN YOUR LOAN*

Owner Occupier Accelerates - Celebrate (LVR < 60%) (Principal and Interest)

  • For a chance to win $100K towards your home loan, apply with Athena before Oct 31 & be approved by Dec 15
  • We lower your rate based off how much you’ve paid down your loan
  • Automatic rate match
VariableMore details
AN EASY ONLINE APPLICATION

Yard Home Loan (Principal and Interest) (Special) (LVR < 70%)

  • Unlimited additional repayments
  • Unlimited free redraws
  • Optional 100% offset can be added for $120 p.a.^
AN EASY ONLINE APPLICATION

Yard Home Loan (Principal and Interest) (Special) (LVR < 70%)

  • Unlimited additional repayments
  • Unlimited free redraws
  • Optional 100% offset can be added for $120 p.a.^
VariableMore details
100% FULL OFFSET ACCOUNTNO APPLICATION FEE OR ONGOING FEES

Low Rate Home Loan - Prime (Principal and Interest) (Owner Occupied) (LVR < 60%)

  • No upfront or ongoing fees
  • 100% full offset account
  • Extra repayments + redraw services
100% FULL OFFSET ACCOUNTNO APPLICATION FEE OR ONGOING FEES

Low Rate Home Loan - Prime (Principal and Interest) (Owner Occupied) (LVR < 60%)

  • No upfront or ongoing fees
  • 100% full offset account
  • Extra repayments + redraw services

Rates correct as of September 27, 2021. View disclaimer.


Can an SMSF buy land?

Yes, an SMSF is permitted to buy land, provided it is vacant land. The Australian Tax Office considers land vacant if:

  • It doesn’t contain a substantial and permanent structure

  • It contains a substantial and permanent structure for residential purposes which was constructed when you held the land and isn’t legally allowed to be lived in or made available for rent.

Unless you’re using your own cash, you’ll need to borrow money to purchase the land, as you typically can’t use the cash in your fund. This is because it's difficult to prove that using the cash to buy the land is in the best interest of the member’s retirement and it can be hard to prove you’re operating on an arm’s length basis.

To get a loan as an SMSF you need something called a limited recourse borrowing arrangement (LRBA). This acts as a protection of sorts for your fund, where in the event you can no longer make repayments on the loan, the lender is limited in its recourse to reclaim assets to get back its money. A separate trust and trustee, known as a custodian, is created, essentially providing your SMSF with a safety net, stopping the lender from repossessing all of the assets in the fund and instead pursuing what's in the LRBA if you default on the loan.

The important thing to note about using an LRBA is you can only purchase a ‘single acquirable asset’ with it, which is a complicated way of saying you can only buy one thing, not multiple. Keep that in mind as it’s important down the track.


Can an SMSF buy land and build?

An SMSF cannot buy land and build due to the rules around LRBA’s. As previously mentioned, when an SMSF borrows money, they can only purchase a single acquirable asset, or one title. If you’re buying land and building on it, this is considered multiple titles, which is prohibited. Additionally, it's no longer considered vacant land. This is because when buying land and building, you’ll need to use a construction loan. Construction loans function very differently from normal home loans, in that the loan is divided into stages based on the process of the build. The ATO judges buying the land and this building process as separate titles.

The rules around LRBAs and SMSFs restrict you from using borrowed money to make an improvement to a single acquirable asset. This means you can’t use borrowed funds to build a property, make repairs, to change the nature or character of a home (like making a four-bedroom home a three-bedroom home), to demolish a home and build a new one or rezone the land.

You might be wondering why these complex rules exist. There’s an element of risk in home loan lending financial institutions accept, it’s how they make their money. LRBA’s are already considered higher risk by lenders as they’re limited in the options in recovering money if you default. If an SMSF was to build on vacant land it bought it would be fundamentally changing the asset, which is the security on the loan. In the lender's eyes, this increases the risk of default as the borrower is taking on more risk by doing this. Furthermore, if the lender was to seize the asset - the land, which is now fundamentally different with a half-built house on it - it's going to be harder for the lender to offload it and recover its losses.


What alternative options are there?

If for whatever reason an SMSF desperately wants to buy land and build property, there is somewhat of a loophole in the restrictions. An SMSF is permitted to buy an off-the-plan apartment, as the contract for buying the land it's built on and the building is all incorporated into the one contract. You also typically wouldn’t use a construction loan to buy off-the-plan, rather a regular home loan.

As as far as other alternative options go, SMSFs are able to purchase established properties using an LRBA. Typically, lenders will require you to have at least a 20% deposit for the purchase of residential properties and in some cases a 30% deposit if buying a commercial property. Lenders need to reduce the risk profile when lending to SMSFs, hence the higher deposit requirement, and it also helps you avoid paying Lenders Mortgage Insurance (LMI).


What to consider prior to buying land with your SMSF

If you’re thinking of buying land with your SMSF, it’s important to consider a number of things prior. It’s vital you consult the trust deed of your SMSF to ensure the purchase of the land is permitted and in the best interest of your trustee’s retirement. Provided the purchase passes this test, consider asking yourself the following questions:

  • Will the land produce any income for the SMSF and if so, how much?

  • Is the income the land produces better than a less risky investment or a savings account?

  • Will the land increase in value and if so, by how much?

  • Have you considered the costs the land will incur like land tax and council rates? How much will these cost the fund?

  • Does the income outweigh the costs? If not, how long will it take to turn a profit, if at all?

  • How would the land be dealt with if a member died or the fund needed to be wrapped up?


Photo by George Pastushok on Unsplash

Disclaimers

The entire market was not considered in selecting the above products. Rather, a cut-down portion of the market has been considered which includes retail products from at least the big four banks, the top 10 customer-owned institutions and Australia’s larger non-banks:

  • The big four banks are: ANZ, CBA, NAB and Westpac
  • The top 10 customer-owned Institutions are the ten largest mutual banks, credit unions and building societies in Australia, ranked by assets under management in November 2020. They are (in descending order): Great Southern Bank, Newcastle Permanent, Heritage Bank, Peoples’ Choice Credit Union, Teachers Mutual Bank, Greater Bank, IMB Bank, Beyond Bank, Bank Australia and P&N Bank.
  • The larger non-bank lenders are those who (in 2020) has more than $9 billion in Australian funded loans and advances. These groups are: Resimac, Pepper, Liberty and Firstmac.
  • If you click on a product link and you are referred to a Product or Service Provider’s web page, it is highly likely that a commercial relationship exists between that Product or Service Provider and Savings.com.au

Some providers' products may not be available in all states. To be considered, the product and rate must be clearly published on the product provider's web site.

In the interests of full disclosure, Savings.com.au, Performance Drive and Loans.com.au are part of the Firstmac Group. To read about how Savings.com.au manages potential conflicts of interest, along with how we get paid, please click through onto the web site links.

*Comparison rate is based on a loan of $150,000 over a term of 25 years. Please note the comparison rate only applies to the examples given. Different loan amounts and terms will result in different comparison rates. Costs such as redraw fees and costs savings, such as fee waivers, are not included in the comparison rate but may influence the cost of the loan.

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Alex joined Savings.com.au as a finance journalist in 2019. He enjoys covering in-depth economical releases and breaking down how they might affect the everyday punter. He is passionate about providing Australians with the information and tools needed to make them financially stable for their futures.

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