What Are Capital Works Restrictions Under an LRBA?

Borrowed funds under a Limited Recourse Borrowing Arrangement cannot be used to improve the property you're buying.

The restriction is built into the legislation. Under sections 67A and 67B of the SIS Act, the money you borrow through an LRBA must be used to acquire a single asset, plus certain acquisition costs like stamp duty and loan establishment fees. That's it. Once the purchase settles, borrowed money cannot be drawn down to renovate, extend, repair, or otherwise improve the asset. This applies to both residential and commercial property held under an LRBA, and it applies whether you're borrowing from a bank, a non-bank lender, or a related party.

The rule exists because an LRBA is designed to fund the acquisition of an asset, not the ongoing operation or enhancement of that asset. The moment you start using borrowed funds to improve what you already own, you've moved outside the scope of what the legislation permits.

Residential LRBAs Entered After August 2026

Residential property acquired under an LRBA entered into from 10 August 2026 onwards is no longer permitted. The Treasury Laws Amendment (Tax Reform No. 1) Act 2026 restricted new LRBAs for real property to business real property only. This does not ban residential property from SMSFs altogether. Your fund can still hold residential property purchased before that date, and you can still buy residential property without borrowing. But if you're entering into a new LRBA arrangement now, the property must meet the definition of business real property under section 66 of the SIS Act.

Consider a member who exchanged contracts on a residential investment property in July 2026 but didn't settle until September. That arrangement is protected under the transitional provisions. Even though the LRBA was formally entered into after the commencement date, the binding contract was exchanged beforehand. The member can proceed, refinance later if needed, and the usual LRBA conditions apply, including the restriction on using borrowed funds for improvements.

What Counts as an Improvement Under the Rules

An improvement is any work that enhances the value, condition, or functionality of the property beyond what existed at acquisition. Renovating a kitchen, adding a second storey, installing a new air conditioning system, or extending a warehouse are all improvements. Repairs that restore an asset to its original condition without adding value may not be classified as improvements for tax purposes, but they still cannot be funded with borrowed money under an LRBA. The line between repair and improvement can be blurry in practice, but the LRBA rule doesn't make that distinction. If the work is done after acquisition, it cannot be funded with borrowed funds.

In our experience, this is where members planning to buy commercial property sometimes get caught. They find a warehouse at a price that works, knowing it needs some internal fit-out or minor structural work to suit a tenant. They assume the loan can cover both the purchase and the upgrades. It can't. Any capital works must come from the fund's existing cash reserves or rental income, not from a drawdown on the loan.

Commercial Property and the Business Real Property Test

SMSF loans for commercial property remain unaffected by the August 2026 changes, but the property must satisfy the business real property definition at the time of acquisition. That means land and buildings used wholly and exclusively in one or more businesses. The business doesn't need to be carried on by your fund. A tenant can operate the business. But the property's actual use, not its zoning or marketing description, determines whether it qualifies.

A retail shop leased to a café operator will generally qualify. A medical consulting suite leased to a GP practice will generally qualify. A property with a residential flat above a shopfront may not qualify, or may only partially qualify, depending on how the space is divided and used. Detailed guidance is set out in SMSFR 2009/1, and the ATO has confirmed that the actual use at acquisition is what matters.

Where a property includes a residential component, the mixed-use character can disqualify it from the business real property definition. The primary production concession allowing up to 2 hectares of dwelling does not apply to other property types. If the property doesn't meet the definition at acquisition, the LRBA cannot proceed.

Funding Capital Works From Fund Cash Reserves

If your fund needs to carry out capital works on a property held under an LRBA, the money must come from the fund's own resources. That includes cash reserves, rental income, or additional contributions made by members within their concessional and non-concessional contribution caps. From 1 July 2026, the concessional cap is $32,500 per annum and the non-concessional cap is $130,000 per annum, subject to the member's total superannuation balance.

As an example, an SMSF holds a small industrial unit purchased under an LRBA before the residential property changes came into effect. The tenant vacates, and the trustees want to replace the roller door and repaint internally before relisting. The cost is around $12,000. That amount must come from the fund's bank account, funded by rental income already received or a member contribution. The loan cannot be increased or redrawn to cover the work, even if the lender is willing.

This restriction also affects how much cash the fund needs to retain after settlement. Many members focus on having enough for the deposit, stamp duty, and loan costs, but don't set aside a buffer for repairs or improvements that might be needed within the first year or two. A property that looks sound at purchase can still require unexpected work, and the fund needs liquid assets to cover it.

Refinancing an Existing LRBA and the Capital Works Rule

Refinancing an LRBA that was in place before 10 August 2026 does not change the capital works restriction. The ATO considers refinancing to mean entering into a new loan contract for the same asset, with the same or a new lender. The refinanced loan must still relate to the same single asset, maintain the limited recourse character, and meet arm's length terms. Borrowed funds under the refinanced arrangement still cannot be used to improve the property.

Where an existing arrangement is significantly changed, the ATO may consider that the original arrangement has ended and a new one has begun. Refinancing that involves borrowing to acquire a different asset, or changes to the ultimate beneficiaries of the arrangement, may trigger this outcome. A new arrangement entered into after 10 August 2026 involving residential property would be subject to the post-commencement rules and could not proceed. Refinancing a compliant commercial LRBA is unaffected by the timing, provided the terms remain consistent with the original arrangement.

Tax Treatment of Capital Works and Rental Income

Capital works funded by the SMSF may be eligible for depreciation deductions under Division 43 of the Income Tax Assessment Act. Structural improvements, extensions, and certain other capital expenditure can be claimed at 2.5 percent per annum over 40 years where the work was completed after 15 September 1987 and the property is used to produce assessable income. These deductions reduce the fund's taxable income and, in accumulation phase, lower the tax payable on rental income and realised capital gains at the concessional rate of 15 percent.

Where the property supports a retirement-phase income stream and the fund's assets are fully segregated, rental income and capital gains may be exempt under the exempt current pension income provisions. The outcome depends on whether the fund uses the segregated or proportionate method, whether an actuarial certificate is required, and whether minimum pension payment requirements have been met. The tax treatment of capital works deductions and rental income is the same whether the property was acquired with or without an LRBA, but the source of funds for the works must comply with the borrowing restrictions.

Practical Considerations When Buying Property Under an LRBA

Before committing to a property purchase under an LRBA, assess what work the property might need over the short to medium term. If the property requires immediate or likely capital works, the fund needs enough cash or projected rental income to cover those costs without relying on borrowed funds. This is particularly relevant for older commercial properties where fit-outs, compliance upgrades, or structural work may be necessary to attract or retain tenants.

The single asset requirement under an LRBA also means you cannot acquire multiple properties on separate titles under one loan, even if they are substantially similar or located next to each other. Each property requires a separate LRBA, and each loan is subject to the same restrictions on capital works funding.

Where the fund is leasing business real property to a related party, the lease must be on arm's length terms at market value. Any failure to meet arm's length requirements may result in income being taxed as non-arm's length income at 45 percent. The ATO publishes safe harbour interest rates for SMSF LRBAs under PCG 2016/5, and these rates are updated annually. Using a rate within the safe harbour range provides protection, but does not override the requirement that all other terms of the arrangement must also be at arm's length.

Call one of our team or book an appointment at a time that works for you. We work with SMSF trustees across Victoria and Australia, and we can help you understand how the capital works restrictions affect your specific situation before you commit to a purchase.

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