What Are the Rules for SMSF Loans in Pension Phase?

Your SMSF can hold property on a loan during both accumulation and pension phase, but the tax treatment shifts when you transition to a retirement income stream.

The property itself doesn't change hands. The loan stays in place. But how rental income and capital gains are taxed depends on whether the fund's assets support a pension, and whether those assets are fully segregated or split between accumulation and pension interests. Getting this wrong can mean paying tax on income you thought would be exempt, or triggering compliance issues you didn't see coming.

How Pension Phase Affects Tax on Rental Income

Rental income from property supporting a retirement-phase income stream may qualify for exempt current pension income (ECPI). If your fund's assets are fully segregated as current pension assets, the rental income is generally tax-free. If the fund uses the proportionate method because it has both accumulation and pension interests, only the exempt proportion of the rental income is tax-free, as determined by an actuarial certificate.

Consider a member in Bairnsdale who transitions their SMSF to pension phase after selling a contracting business. The fund holds a commercial property in the industrial precinct near the airport, leased to an unrelated logistics operator. The property was acquired under a limited recourse borrowing arrangement several years ago and the loan is still being repaid. Before the transition, rental income was taxed at 15 percent in the fund. After the member commenced a pension and the fund segregated all assets as pension assets, the rental income became exempt. The loan repayments continue from the fund's cash flow, but the tax burden on that income dropped to zero.

Capital Gains Tax When You Sell During Pension Phase

A capital gain is not automatically tax-free just because your SMSF is paying a pension. The exemption applies only to assets supporting a retirement-phase income stream, and how much of the gain is exempt depends on whether the fund's assets are segregated or proportioned.

Where assets are fully segregated as current pension assets, a capital gain on disposal is disregarded. Where the fund uses the proportionate method, the exemption applies only to the exempt proportion of the net capital gain. The outcome depends on the method used to calculate ECPI, whether minimum pension payment requirements have been satisfied, and the fund's transfer balance cap position.

In a scenario where a member holds both accumulation and pension interests, the fund would need an actuarial certificate to work out the exempt proportion. If the fund sells a property partway through the year, the calculation becomes more involved. The timing of the sale, the proportions at different points in the year, and the fund's overall position all feed into the final tax outcome. This isn't something you guess at.

What Happens If Your Balance Exceeds $3 Million

From 1 July 2026, Division 296 tax applies where a member's total superannuation balance at the end of the financial year exceeds $3 million. The tax is 15 percent on the proportion of earnings attributable to the amount above that threshold. If the balance exceeds $10 million, an additional 10 percent applies to earnings above that level.

Division 296 fund earnings are based on an adjusted amount of the fund's taxable income. Rental income and realised capital gains may contribute to the calculation. An unrealised increase in property value does not by itself produce assessable income or Division 296 fund earnings. The fund must trigger a CGT event, such as selling the property, for the gain to form part of the earnings base. LRBA amounts are disregarded when calculating a member's total superannuation balance for Division 296 purposes, so the outstanding loan doesn't inflate the threshold test.

Refinancing an Existing SMSF Loan After Transition

You can refinance an SMSF loan after transitioning to pension phase, but the arrangement must remain a limited recourse borrowing arrangement and meet arm's length terms. The loan must relate to the same single asset, and the limited recourse character of the original arrangement must be maintained.

The ATO publishes safe harbour interest rates for SMSF loans under Practical Compliance Guideline PCG 2016/5, updated annually. If the refinanced loan doesn't meet arm's length terms, income from the arrangement may be assessed as non-arm's length income and taxed at 45 percent, even if the fund is in pension phase. That wipes out any tax benefit from ECPI.

For commercial properties, refinancing is not affected by the restriction on new residential limited recourse borrowing arrangements that commenced in August. For residential properties acquired under an LRBA before that date, refinancing may be permitted as maintaining or refinancing an existing arrangement, but detailed guidance had not been published as at the date of this article. Significant changes to the terms or conditions of an LRBA can end the existing arrangement and trigger a new one, which may not be permitted under the post-commencement rules. Trustees should seek advice from a licensed SMSF specialist and a mortgage broker with SMSF experience before refinancing a residential LRBA.

Contributions and Pensions in the Same Year

You can make contributions to your SMSF in the same year you draw a pension, but the contributions sit in the accumulation phase unless they are specifically allocated to the pension account. The concessional contributions cap is $32,500 per annum from 1 July 2026. The non-concessional contributions cap is $130,000 per annum, with bring-forward arrangements available depending on your total superannuation balance.

If you're still making concessional contributions while drawing a pension, the fund will have both accumulation and pension interests. That means the fund uses the proportionate method for ECPI unless the assets are later fully segregated. The fund will need an actuarial certificate each year to work out the exempt proportion of its income. This affects how rental income and capital gains from the LSBA property are taxed.

If the property is held in a bare trust under the LRBA, the beneficial interest is attributed to the SMSF, and the proportionate method still applies to the fund's overall income. The transition to pension phase doesn't change the structure of the LRBA or the holding trust. It changes how the income and gains from the property are taxed once they flow through to the SMSF.

Should You Sell or Hold After Transition?

The decision to sell or hold property after transitioning to pension phase depends on your cash flow needs, the fund's overall asset allocation, and the tax outcome on disposal. If the fund's assets are fully segregated as pension assets, selling the property produces no capital gains tax. If the fund uses the proportionate method, only part of the gain is exempt.

Selling a property in pension phase with full segregation can be a tax-effective way to rebalance the fund's portfolio or release capital to fund pension payments. But if the loan is still being repaid and the property produces strong rental income, holding may make more sense. The rental income is tax-free if the fund is fully in pension phase, and the loan is gradually paid down from that income.

If your total superannuation balance exceeds $3 million, Division 296 tax may apply to earnings above that threshold. Realising a large capital gain in that scenario could increase the Division 296 liability, even if the gain itself is partly or fully exempt from standard income tax under ECPI. The interaction between ECPI and Division 296 is complex and depends on the fund's specific circumstances. This is where advice from an SMSF specialist becomes necessary, not optional.

Call one of our team or book an appointment at a time that works for you. We work with SMSF trustees across Bairnsdale and the wider Gippsland region, and we can connect you with the specialists you need to get this right.

Frequently Asked Questions