Why SMSF Loans Now Favour Smaller Commercial Dwellings

LRBAs Can No Longer Be Used for Residential Property

From 10 August 2026, self-managed super funds cannot enter into new limited recourse borrowing arrangements to purchase residential property. The Treasury Laws Amendment (Tax Reform No. 1) Act 2026 restricts new LRBAs involving real property to business real property only. This does not prevent SMSFs from owning residential property outright, but borrowing to acquire it is no longer permitted.

Consider a member with $450,000 in their SMSF who previously might have borrowed $350,000 to acquire a residential unit in Parramatta. That strategy is no longer available if the arrangement is entered into after 10 August 2026. The same member can still use an SMSF loan to acquire a smaller commercial dwelling such as a retail shopfront, office suite, or industrial unit, provided the property satisfies the business real property definition under section 66 of the SIS Act.

Existing residential LRBAs entered into before 10 August 2026 are unaffected. Trustees with compliant arrangements in place can continue to hold, refinance, and eventually sell those properties without restriction. The change applies only to new arrangements involving residential real property.

What Qualifies as Business Real Property

Business real property means land and buildings used wholly and exclusively in one or more businesses. The business does not need to be carried on by the fund or the entity holding the property. A small commercial office leased to a tenant operating an accounting practice qualifies. A warehouse leased to a logistics business qualifies. A retail shopfront leased to a cafe operator qualifies, provided the property is used for the cafe business and not as a residence.

The definition depends on actual use at the time of acquisition, not on how the property is marketed or zoned. A property advertised as commercial does not automatically satisfy the test. If a property includes a residential component or is used partly for private purposes, it may not qualify or may only partially qualify depending on the specific circumstances.

In our experience, smaller commercial properties such as ground-floor retail units, small office suites, and strata-titled industrial units often provide the most accessible entry point for SMSF trustees who want to borrow. These properties typically require lower deposits in absolute terms than larger commercial assets and are more likely to secure lending approval from specialist SMSF mortgage brokers who understand the legislative framework.

Deposit and Borrowing Capacity for Commercial LRBAs

Most lenders offering commercial SMSF property loans require a minimum deposit of 30 to 35 percent of the purchase price, which translates to a maximum loan-to-value ratio of 65 to 70 percent. Some lenders may lend up to 80 percent LVR in specific circumstances, but this is uncommon and typically limited to properties in prime locations with strong tenancy profiles.

A member looking to acquire a small commercial property at $600,000 would need approximately $210,000 in their SMSF to satisfy a 35 percent deposit requirement, plus settlement costs including stamp duty, legal fees, and loan establishment fees. Borrowing capacity depends on the rental income the property generates, the fund's ability to service the loan from rental income and contributions, and the member's balance and contribution history.

Unlike residential lending, commercial lenders assess rental income based on actual lease terms rather than estimated market rent. A property with a signed lease to a creditworthy tenant at market rent will support higher borrowing capacity than a vacant property or one leased below market. Lenders also consider lease duration, tenant quality, and whether the lease is on arm's length terms.

The Single Asset Rule and Separate Title Properties

An LRBA can only be used to acquire a single asset or a collection of identical assets with the same market value that can be treated as a single asset. Multiple real property titles cannot be acquired under a single LRBA unless the properties are distinctly identifiable as a single asset, meaning they are bought and sold together and have equal market value.

A small commercial unit on a single strata title satisfies the single asset requirement. Two adjacent retail units on separate strata titles, even if substantially similar, do not qualify under a single LRBA. Each would require a separate borrowing arrangement.

This restriction matters for trustees considering smaller dwellings because many affordable commercial properties are sold as strata-titled units rather than whole buildings. A strata office suite or retail shopfront can be acquired under an LRBA, but attempting to acquire multiple units in the same development under one arrangement would breach the single asset rule.

Why Leasing to a Related Party Requires Careful Structuring

Business real property leased to a related party of the fund is excluded from the in-house asset rules, but the lease must be on arm's length terms at market rent. A related party in this context includes a member, a relative of a member, a business controlled by a member, or another entity connected to the fund.

Consider a scenario where an SMSF acquires a small commercial office suite under an LRBA and leases it to a company controlled by one of the fund members. The lease must reflect market rent, include terms consistent with comparable leases in the area, and be documented formally. If the rent is below market, the ATO may assess the income as non-arm's length income, which is taxed at 45 percent rather than the concessional rate of 15 percent.

We regularly see this arrangement used by self-employed workers operating through a company structure, particularly in professional services. The structure works well when the lease is properly documented and independently valued, but it creates compliance risk if the terms are not maintained at arm's length.

How Capital Gains Tax Applies to Commercial Property in an SMSF

A complying SMSF is taxed at 15 percent on assessable income, including net capital gains. Where the property has been held for at least 12 months, a one-third CGT discount applies, which can produce a maximum effective rate of 10 percent on the discounted gain. The actual tax liability depends on the property's cost base, acquisition and selling costs, capital improvements, capital works deductions, and the fund's overall tax position.

Where the fund's assets are fully segregated as current pension assets at all times during the income year, a capital gain on disposal of those assets is disregarded. From the 2022 financial year, where all of a fund's assets are paying retirement phase pension benefits at all times of the year, the fund's assets are regarded as segregated. Where the fund uses the proportionate method because it holds both accumulation and pension interests, the exemption applies only to the exempt proportion of the net capital gain.

Division 296 tax applies from 1 July 2026 to members whose total superannuation balance exceeds $3 million at year end. LRBA amounts are disregarded when calculating a member's balance for Division 296 purposes, meaning the outstanding loan does not count toward the threshold. However, rental income and realised capital gains from the property may contribute to the Division 296 earnings calculation. An SMSF may elect to adjust the cost base of its CGT assets to market value as at 30 June 2026, which recognises accrued value prior to the commencement of Division 296 tax.

Refinancing an Existing Residential LRBA Remains Permitted

The changes commencing 10 August 2026 do not impact the refinancing of arrangements existing prior to that date. Trustees with compliant residential LRBAs in place before 10 August 2026 can refinance to another lender without the refinanced arrangement being subject to the post-commencement rules.

Refinancing means entering into a new loan contract for the same asset, with the same or a new lender. The refinanced loan must relate to the same single acquirable asset, maintain the limited recourse character of the original arrangement, and meet arm's length terms consistent with the ATO's safe harbour interest rates published under Practical Compliance Guideline PCG 2016/5.

A significant change to the terms or conditions of an LRBA may end the arrangement and create a new one. Circumstances that may end an existing arrangement include refinancing that is inconsistent with the original arrangement, borrowing to acquire an asset not contemplated under the original arrangement, and changes to the ultimate beneficiaries. A new arrangement entered into on or after 10 August 2026 involving residential property would be subject to the post-commencement rules and could not proceed.

Why Sole Purpose Compliance Matters More with Commercial Property

The sole purpose test under section 62 of the SIS Act requires trustees to ensure the fund is maintained solely to provide retirement benefits to members. All SMSF investments, including commercial property held under an LRBA, must satisfy this test at all times.

Commercial property leased to a related party can create sole purpose risk if the lease terms provide the related party with a benefit that is not consistent with arm's length dealings. A below-market lease, a rent-free period that exceeds what an independent tenant would receive, or lease terms that favour the tenant beyond what is commercially reasonable may indicate that the arrangement provides a present-day benefit to the member or related party rather than a retirement benefit to the fund.

Similarly, a property acquired at above-market value, or one that does not generate sufficient income to service the loan and meet the fund's obligations, may raise questions about whether the acquisition was made in the fund's interests or to provide a benefit to a related party. These risks are not unique to smaller commercial properties, but they require closer attention where the tenant is a related party or the property is acquired from a related business.

Borrowed funds cannot be used to improve an existing asset under an LRBA. Capital improvements must be funded from the SMSF's own resources, which can limit the fund's ability to enhance the property or respond to tenant requirements. This is particularly relevant for smaller commercial properties where fit-out or refurbishment may be required to secure or retain tenants.

Whether you are considering a small commercial property acquisition, refinancing an existing residential LRBA, or reviewing your fund's compliance with the new rules, call one of our team or book an appointment at a time that works for you. We work with SMSF trustees across greater Sydney and can connect you with specialist lenders and licensed SMSF advisers who understand how these changes affect your fund.

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