SMSF Bare Trusts: A Complete Guide
Comprehensive guide to SMSF bare trusts for property purchases under an LRBA. Learn structure, benefits, setup process, compliance rules, and costs.
SMSF Bare Trusts: A Complete Guide
Understanding Bare Trusts in the Context of SMSFs
A self-managed superannuation fund (SMSF) is a structure that gives members direct control over investment choices. When an SMSF decides to purchase property using borrowed funds, strict superannuation laws apply. These laws prohibit an SMSF from holding the legal title to an asset purchased with a loan unless a specific arrangement is in place. That arrangement is the bare trust.
A bare trust is a legal structure where the trustee holds the legal title to an asset, but the SMSF retains the beneficial ownership. The trustee acts only on the instructions of the SMSF trustee. The bare trust does not actively manage or use the asset; it exists solely to hold the property until the loan is repaid.
Bare trusts are essential for ensuring compliance with the Superannuation Industry (Supervision) Act 1993 (SIS Act) when an SMSF uses a Limited Recourse Borrowing Arrangement (LRBA) to buy property. Without this structure, the purchase would breach superannuation laws.
The Role of a Bare Trust in an LRBA
Under an LRBA, the SMSF borrows money to acquire a single acquirable asset. Because the borrowing is limited recourse, the lender can only claim the asset held in the bare trust if the loan defaults. Other SMSF assets remain protected.
The bare trust acts as a legal ‘holding trust’ where the property sits until the loan is repaid. The SMSF receives the rental income, pays expenses, and benefits from any capital growth, but legal title remains with the bare trustee.
This arrangement safeguards the SMSF and aligns with superannuation regulations. It also makes the process clearer for lenders, as they know their security is restricted to the property in question.
Legal Structure of a Bare Trust
A bare trust arrangement typically involves:
- SMSF Trustee – Holds beneficial ownership of the asset and manages the SMSF.
- Bare Trustee – Holds legal title to the asset and acts only on the SMSF trustee’s instructions.
- Trust Deed – Outlines the terms of the bare trust and is essential for legal compliance.
- Loan Agreement – Establishes the borrowing terms under the LRBA.
- Property Contract – Names the bare trustee as the purchaser of the property.
The bare trustee is often a separate company established specifically for this role. This separation ensures compliance and avoids conflicts of interest.
Key Benefits of Using a Bare Trust
- Legal Compliance – Meets superannuation law requirements for property purchases with borrowed funds.
- Asset Protection – Restricts lender access to the purchased asset only.
- Clarity of Ownership – Beneficial ownership sits with the SMSF, protecting members’ interests.
- Simplified Transfer – Once the loan is repaid, legal title can be transferred to the SMSF without triggering capital gains tax or stamp duty in most states, provided the arrangement is set up correctly.
When a Bare Trust is Required
A bare trust is required when:
- An SMSF purchases a property using borrowed funds under an LRBA.
- The loan is secured only against the asset being acquired.
- The SMSF intends to hold the property long-term as part of its investment strategy.
It is not required if the SMSF buys the property outright with existing funds, or if the asset is not property.
Step-by-Step Process of Setting Up a Bare Trust
Step 1: Review SMSF Trust Deed
Check that the SMSF trust deed allows borrowing under an LRBA and investment in property. If not, it must be updated.
Step 2: Create a Bare Trust Deed
A solicitor or qualified accountant prepares the bare trust deed. This document must clearly define the trustee’s limited role and the SMSF’s beneficial ownership.
Step 3: Appoint the Bare Trustee
Appoint a separate legal entity, often a corporate trustee, to hold legal title.
Step 4: Sign the Contract of Sale
The bare trustee is named as purchaser on the property contract, not the SMSF trustee.
Step 5: Arrange the Loan
The SMSF applies for the loan. The lender will require the bare trust documentation before approval.
Step 6: Complete Settlement
The bare trustee holds legal title after settlement. The SMSF receives rental income and pays expenses.
Step 7: Manage the Property
The SMSF manages the asset, ensures compliance with LRBA terms, and maintains accurate records.
Step 8: Transfer Legal Title After Loan Repayment
Once the loan is fully repaid, the property’s legal title can be transferred to the SMSF.
Common Mistakes to Avoid
- Naming the SMSF trustee as purchaser on the property contract instead of the bare trustee.
- Setting up the bare trust deed after signing the property contract, which can cause stamp duty issues.
- Using the same entity as both SMSF trustee and bare trustee.
- Not aligning the trust deed terms with the LRBA and property contract.
- Failing to update the SMSF trust deed before starting the process.
State-Based Stamp Duty Considerations
Stamp duty rules differ across states and territories. In some states, the transfer of legal title from the bare trustee to the SMSF after the loan is repaid is exempt from duty if certain conditions are met. In others, strict timing and documentation requirements apply. Failure to comply can result in double duty.
Tax and Compliance Implications
The SMSF is the beneficial owner from the start. All income and expenses are recorded in the SMSF’s accounts. The bare trustee does not lodge a separate tax return.
The arrangement must comply with:
- SIS Act provisions
- Australian Taxation Office LRBA guidelines
- Trust law requirements
Accurate record-keeping is essential. All transactions should be documented, and minutes of trustee meetings maintained.
Bare Trust for Commercial vs Residential Property
Bare trusts can be used for both commercial and residential properties. In both cases, the same compliance rules apply, but investment strategies differ.
- Commercial Property – Often purchased for business premises, possibly leased to a related party under arm’s length terms.
- Residential Property – Must be strictly for investment. SMSF members and related parties cannot live in or rent the property.
Bare Trust Costs
Professional fees vary depending on complexity. At Trinity Accounting Practice, a complete bare trust setup, including deed preparation and compliance review, is charged at $2,000 + GST. This covers all documentation and guidance to ensure your arrangement is compliant from the outset.
Ongoing Obligations
Once the bare trust is established:
- Maintain the property as part of the SMSF’s investment strategy.
- Ensure the LRBA is repaid according to terms.
- Keep the bare trust inactive except for holding legal title.
- Monitor compliance with super laws annually.
Advantages and Disadvantages
Advantages:
- Enables property purchase using borrowed funds within an SMSF.
- Limits lender’s recourse to the purchased asset.
- Provides a clear structure for ownership and compliance.
Disadvantages:
- Adds complexity to the SMSF.
- Involves additional setup and legal costs.
- Requires strict adherence to documentation and compliance rules.
Final Transfer Process
When the loan is fully repaid:
- Prepare documentation for the transfer of legal title from the bare trustee to the SMSF.
- Apply for any available stamp duty exemptions.
- Update property records and notify relevant authorities.
If the arrangement was set up correctly, this process is straightforward and does not trigger additional tax or duty.
Why Proper Setup is Critical
Incorrect setup can lead to:
- Breach of super laws.
- Stamp duty penalties.
- Loan refusal by lenders.
- Capital gains tax issues.
- Loss of SMSF’s concessional tax treatment.
Professional assistance ensures compliance and protects your SMSF investment.
Conclusion
A bare trust is a key legal structure for SMSFs investing in property with borrowed funds. It ensures compliance, protects other fund assets, and allows for a smooth transfer of legal title once the loan is repaid. While it adds complexity, the benefits for SMSF property investors are significant when established correctly.
At Trinity Accounting Practice, the bare trust setup service ensures your arrangement is legally sound and tailored to your SMSF’s needs.
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