SMSF Loans and Capital Works: What You Need to Know

When you hold property in your SMSF through a Limited Recourse Borrowing Arrangement, you cannot use borrowed funds to improve that asset.

This restriction affects both residential and commercial property and applies throughout the life of the LRBA. If you are rebuilding financial independence after divorce and considering property investment through your SMSF, understanding these limitations before you commit to a purchase will help you choose the right asset and structure your loan appropriately.

Why Borrowed Funds Cannot Be Used for Improvements

The SIS Act permits SMSFs to borrow only to acquire a single asset or a collection of identical assets. The borrowed money can cover the purchase price, loan establishment costs, and stamp duty, but cannot extend to improving an existing asset. For LRBAs entered into from 7 July 2010 onwards, additional drawdowns for capital improvements are prohibited. This means you cannot return to your lender and request additional funds to renovate a kitchen, add a deck, or undertake any other improvement to the property.

Consider a member who purchases a commercial warehouse through their SMSF using an LRBA. The property is tenanted and producing rental income, but three years later the roof needs replacing. The SMSF cannot draw down further funds under the existing loan to pay for this work. The cost must be met from the SMSF's available cash reserves or income. If the fund lacks sufficient cash, the trustees would need to sell other assets, make additional contributions within the contribution caps, or potentially face a situation where the property cannot be maintained to a standard that preserves its value and tenant appeal.

What Counts as an Improvement Under LRBA Rules

An improvement is any work that enhances the asset beyond its condition at the time of acquisition. Repairs and maintenance that restore the property to its original condition are permitted, but any addition, extension, or upgrade that increases the property's value or functionality is considered an improvement. Replacing damaged carpet with identical carpet is generally considered maintenance. Installing new floorboards where carpet previously existed is an improvement. The distinction is not always clear and depends on the specific circumstances.

Where a property requires significant capital works to reach its full potential, those works must be factored into your acquisition decision. If you are purchasing commercial property that will require fitout or renovation, you need to ensure your SMSF will have sufficient cash flow or reserves to fund those works separately from the LRBA. This planning becomes particularly important when you are dividing assets after separation and your SMSF balance may be lower than it was previously.

Commercial Property Held Under an LRBA

Commercial property held under an LRBA must satisfy the business real property definition under section 66 of the SIS Act, meaning land and buildings used wholly and exclusively in one or more businesses. The restrictions on improvements apply equally to commercial property held through an LRBA. You can acquire the property with borrowed funds, but any subsequent capital works must be funded from the SMSF's own resources.

A member operating a sole trader business might lease commercial premises from their SMSF. If the premises require renovation to suit the business, those renovation costs cannot be funded by drawing down additional amounts under the LRBA. The SMSF must have sufficient reserves to meet those costs. If the SMSF cannot fund the works, the member would need to make personal contributions to the fund, subject to contribution caps, or the renovation would need to be deferred until the fund accumulates sufficient rental income or other investment returns.

How to Structure Your Purchase When Improvements Are Likely

When you know a property will require capital works, the most practical approach is to ensure your SMSF has sufficient cash reserves at the time of purchase or a clear plan to accumulate those reserves from rental income and contributions. Some trustees choose to borrow a lower amount than their maximum borrowing capacity permits, preserving cash within the fund to meet future improvement costs. Others select properties that require minimal work and can generate income immediately without further investment.

If you are purchasing a commercial property with a tenant in place, review the lease terms carefully. Some leases place responsibility for certain works on the landlord. If your SMSF will need to fund fitout contributions or building upgrades during the lease term, those costs must be met from available cash. Failing to meet those obligations could place the lease at risk and affect the property's income.

Refinancing an Existing LRBA

Refinancing an LRBA means entering into a new loan contract for the same asset, with the same or a new lender. The ATO's position is that refinancing does not end an existing arrangement provided the refinanced loan relates to the same single asset, maintains the limited recourse character of the original arrangement, and meets arm's length terms. You cannot use a refinance to draw down additional funds for capital improvements. The new loan must be for the same purpose as the original loan, which was to acquire the asset, not to improve it.

For those holding residential property under an LRBA entered into before 10 August 2026, refinancing to a different lender remains available without triggering the new restrictions on residential LRBAs. The prohibition on using borrowed funds for improvements continues to apply regardless of when the LRBA was entered into or whether it has been refinanced.

Managing Cash Flow When Improvements Are Needed

Maintaining adequate cash reserves within your SMSF is particularly important when property is held under an LRBA. Rental income can be used to cover loan repayments, but any surplus should be retained or reinvested with an eye to future capital expenditure. Where your SMSF holds a single property and limited other assets, a significant repair or improvement cost can create cash flow pressure.

Members who are rebuilding their financial position after separation may have lower superannuation balances and less capacity to make additional contributions. If your SMSF balance is below the large super balance threshold of $3 million, you can make concessional contributions up to $32,500 per annum and non-concessional contributions up to $130,000 per annum. Where your total superannuation balance was below $1.84 million on 30 June of the previous year, the bring-forward arrangement allows non-concessional contributions of up to $390,000 over three years. These contributions can be used to build reserves within the fund to meet future capital works costs, but contribution caps limit how quickly you can increase the fund's cash position.

Sole Purpose Test and Investment Decisions

Every decision made by SMSF trustees must satisfy the sole purpose test under section 62 of the SIS Act, which requires the fund to be maintained solely to provide retirement benefits to members. Choosing a property that requires significant improvement work the fund cannot afford, or deferring necessary maintenance to the point where the property's value is at risk, may raise questions about whether the trustees are acting in accordance with this test. The inability to fund improvements from borrowed funds does not excuse trustees from their obligation to maintain the asset appropriately.

When you are selecting property for your SMSF, consider not only the purchase price and loan serviceability but also the likelihood of capital expenditure over the period you intend to hold the asset. A property purchased at a lower price that requires extensive renovation may appear to offer value, but if your SMSF lacks the cash to fund those works, the opportunity may not be suitable for your circumstances.

Call one of our team or book an appointment at a time that works for you. We work with SMSF specialists and can help you understand how LRBA restrictions affect your property investment options and structure your lending to suit your fund's cash flow and long-term goals.

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