When to Improve Property in Your SMSF

If your SMSF owns property through a Limited Recourse Borrowing Arrangement, you cannot use borrowed funds to improve it.

That restriction applies to both residential and commercial property held under an LRBA. The rule stems from the single asset requirement in sections 67A and 67B of the Superannuation Industry (Supervision) Act. Borrowed money can only be used to acquire a single asset, not to enhance or change it after settlement. Stamp duty, loan establishment costs, and other acquisition expenses can be covered, but capital works and improvements must be funded from existing SMSF assets.

What Counts as an Improvement

An improvement is any work that changes the character of the asset or adds to its capital value. Renovations, extensions, subdivisions, and development work all fall into this category. Repairs and maintenance that restore the property to its original condition do not.

Consider a Service NSW employee whose SMSF purchased a commercial warehouse in 2022 under an LRBA. The fund now wants to add a mezzanine level to increase leasable space. That work would change the asset acquired under the original borrowing. The fund can proceed, but it must use existing cash or investment returns to pay for the mezzanine. Drawing down additional borrowed funds for the work would breach the LRBA conditions and put the arrangement offside with the tax office.

The distinction between repair and improvement matters when planning annual maintenance. Replacing a worn roof with the same materials is repair. Upgrading to solar panels as part of that roof work is improvement. Repainting in the same colour is repair. Reconfiguring the internal layout is improvement.

Why the Restriction Exists

The borrowed funds rule protects the limited recourse character of the arrangement. When a lender advances money under an LRBA, their recourse in the event of default is limited to the asset held in the bare trust. If additional borrowed money were used to improve that asset, the lender's security position would become unclear. The single asset requirement keeps the security and the borrowing aligned.

This limitation affects long-term planning for SMSF property. A fund that borrows to acquire an older property with renovation potential cannot draw down staged funds as the work progresses. The entire improvement cost must come from contributions, rollovers, or investment returns already held by the fund. That usually means either delaying the work until sufficient cash is available or limiting the scope of improvements to match available reserves.

Funding Improvements from Existing Assets

Most SMSFs fund capital works from rental income that has accumulated in the fund or from additional contributions made by members. The fund's cash flow determines how quickly improvement work can proceed.

A Service NSW employee with a total superannuation balance of $480,000 and an SMSF residential property loan entered into before the August 2026 ban might plan a bathroom and kitchen renovation costing $65,000. If the property generates $28,000 in annual rent and loan repayments total $22,000, the fund retains $6,000 per year after meeting the loan obligation. At that rate, it would take more than ten years to fund the renovation from rental income alone. The member could make additional concessional contributions up to the annual cap of $32,500 to accelerate the timeline, but that reduces the contributions available for other purposes and may affect tax planning in the accumulation phase.

Where a member has already satisfied a condition of release and moved into pension phase, contributions are no longer an option. The fund must rely on rental income, the sale of other investments, or deferring the improvement work until the LRBA is repaid and the property is held outright.

Refinancing and the Improvement Restriction

Refinancing an existing LRBA does not allow you to borrow additional funds for improvements. The refinanced loan must relate to the same single asset acquired under the original arrangement. Increasing the loan balance to fund capital works would create a new borrowing for a different purpose, and that is not permitted under the SIS Act.

Existing residential LRBAs entered into before approximately 10 August 2026 are grandfathered under the Treasury Laws Amendment (Tax Reform No. 1) Act 2026. Those arrangements can be maintained or refinanced, but the refinancing must remain consistent with the original terms. As at early July 2026, the ATO had not published updated guidance on what constitutes maintaining or refinancing a grandfathered arrangement versus entering into a new one. Under the ATO's existing position in Practical Compliance Guideline PCG 2016/5, a significant change to the terms or conditions of an LRBA ends the arrangement and a new one begins. Borrowing to acquire an asset not contemplated under the original arrangement is one of the circumstances the ATO has identified as ending an existing LRBA.

If you are considering refinancing an SMSF loan and want to fund improvement work at the same time, those must be treated as separate transactions. The property can be refinanced within the limits of the original acquisition cost, and improvements can be funded separately from existing SMSF cash. Combining the two into a single increased loan will likely be treated as a new borrowing arrangement. For residential property, any new arrangement entered into after the ban takes effect would not be permitted.

Commercial Property and Business Real Property Rules

Commercial property that satisfies the business real property definition under section 66 of the SIS Act is not affected by the 2026 residential ban. LRBAs for commercial property remain available. The same improvement restrictions apply. Borrowed funds cannot be used to improve the asset, even if that asset is commercial.

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 SMSF. A warehouse leased to an unrelated trading company qualifies. A mixed-use property where part of the building is used for business and part is residential may not qualify unless the residential component is incidental. Detailed guidance is set out in SMSF Ruling 2009/1.

Where an SMSF holds commercial property under an LRBA and the trustee wants to reconfigure the space to suit a new tenant, that work must be funded from existing SMSF assets. Fit-out costs, new partitions, upgraded amenities, and similar capital works all fall within the improvement restriction. Repairs that restore the property to its condition before tenant occupation are generally permissible, but anything that adds to the property's market value or changes its character is treated as an improvement.

Planning Capital Works Before Acquisition

The most reliable way to fund improvements is to complete the work before the SMSF acquires the property. Once the property is renovated or developed, the SMSF can borrow to acquire it in its improved state. The single asset acquired under the LRBA is then the completed property, not the original unrenovated version.

This approach requires access to capital outside the SMSF. For Service NSW employees with property held personally or in a family trust, one option is to complete renovation work using personal funds or a standard investment loan, then sell the improved property to the SMSF under an LRBA. The sale must occur at market value and meet all the usual related party and sole purpose test requirements. The property cannot be residential if the LRBA is entered into after the August 2026 ban takes effect.

Another option is to acquire a newly completed property or a commercial premises that already meets the fund's requirements without further work. That eliminates the need to fund improvements during the life of the loan. The trade-off is a higher purchase price and potentially lower rental yield compared to an older property with renovation potential.

Repairs, Maintenance, and Ongoing Costs

Ordinary repairs and maintenance are funded from rental income or existing SMSF cash. These costs do not fall within the improvement restriction because they restore the property to its original condition rather than enhancing it.

Under an LRBA, the SMSF trustee is responsible for all outgoings related to the property. Council rates, water charges, insurance, property management fees, and routine maintenance are all paid from the fund. Those costs reduce the net rental income available for loan repayments or future capital works. Where the property is residential and tenanted, the landlord remains responsible for structural repairs, even if the tenant caused the damage through ordinary use.

For commercial property leased to a related party, all terms including responsibility for repairs and outgoings must be set at arm's length. The lease should be documented and reviewed regularly. If the related party is responsible for maintenance under the lease, the SMSF cannot later claim a deduction for work it funds directly. This is relevant for Service NSW employees who operate a side business through a family company and lease commercial premises from their SMSF. The arrangement must be structured as it would be between unrelated parties, with clear obligations on both sides.

Selling and Replacing the Property

Once the loan is repaid, the SMSF holds the property outright and can use fund assets to improve it, sell it, or acquire a different property. Some trustees repay the LRBA early using additional contributions or by selling other investments within the fund. That accelerates access to the property's full equity and removes the restriction on using borrowed funds for improvements.

If the goal is to upgrade or develop the property and the LRBA still has several years to run, an alternative is to sell the property while it is still held in the bare trust, repay the loan from the sale proceeds, and use the remaining funds to acquire a different property that better suits the fund's objectives. Any capital gain or loss is assessed in the SMSF and taxed at the fund's rate, which is 15 percent in accumulation phase or nil in pension phase if held for more than 12 months. The SMSF can then acquire another investment property using existing assets or by entering into a new LRBA if the property is commercial.

Selling and replacing a property involves transaction costs including agent fees, stamp duty, and legal fees. Those costs reduce the net amount available for reinvestment. The decision to sell should be made in the context of the fund's overall investment strategy and the member's long-term retirement objectives.

If your SMSF holds property under a Limited Recourse Borrowing Arrangement and you are weighing up capital works, timing, or refinancing, call one of our team or book an appointment at a time that works for you. We work with Service NSW employees on SMSF lending and can walk through your options with a licensed SMSF specialist where needed.

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