SMSF Series 5 - Renovating an SMSF Property

SMSF are required to comply with strict rules and regulations when it comes to making changes or improvements to SMSF property. These rules are in place to ensure that the Sole Purpose Test ("providing retirement benefits to its members") of the SMSF is met.

In this article below, we’ll outline what you can and can’t renovate when you own a property through your SMSF.

How You Bought Your SMSF Property Matters

Whether or not you can make improvements to SMSF property depends on how your SMSF purchased the property.

If you purchased your SMSF property outright and it does not have a mortgage then you may use existing funds to make improvements to the property. Subject to what it outlined in your SMSF deed and meeting the Sole Purpose of the SMSF ("providing retirement benefits to its members"), renovations that increase the property’s value or change its structure may be allowed.

On the other hand, if you financed the purchase with an SMSF loan, you are not permitted to use borrowed money to make any improvements to the property. However, existing fund balance held in your SMSF can be used to make improvements to this property, as long as the improvements do not result in the asset becoming a "different asset". 

Golden Rule when Borrowing an SMSF Loan

No Improving!

One of the key rules of using an SMSF loan to purchase property through SMSF is that you can’t improve the property with borrowed money. You can maintain and repair the property, but adding something new or making it significantly better than it was originally is not allowed.

Case 1: Renovations on a Property Purchased without an SMSF Loan (Outright)

If your SMSF purchased a property without borrowing (outright), there is flexibility with limited restrictions. You can make both repairs and improvements. Renovations that increase the property’s value or change its structure are allowed, as long as the Sole Purpose Test of the SMSF (providing retirement benefits) is still met and the SMSF funds all renovations from its existing cash reserves. However, borrowing is not allowed to fund improvements.

1. What you can do:

   • Adding a new room

   • Installing a swimming pool

   • Converting a garage into a living space

   • Upgrading kitchens and bathrooms

   • Modernising outdated structures

   • Landscaping or adding outdoor living spaces

2. What you can't do:

   • Renovations must align with the SMSF’s investment strategy. For example, overly luxurious renovations that do not fit with the property’s intended use as a retirement asset could potentially breach SMSF rules.

   • Also enhancements that transforms the asset into a "different asset" are not allowed.

Case 2: Renovations on a Property Purchased with an SMSF Loan

When a property is purchased using borrowed funds, stricter rules are applied and improvements are limited to repairs and maintenance. This means you can only restore the property to its original state or fix something that is broken with borrowed money.

1. What you can do: The following examples of repairs are necessary to maintain the property and keep it in good condition without enhancing or significantly altering its value. Importantly, the repairs must not change the property’s nature or function.

   • Fixing a leaky roof

   • Replacing broken windows or doors

   • Repainting walls

   • Restoring damaged floorboards

2. What you can't do: The following improvements could be seen as changing the fundamental value or nature of the property, which is not allowed when the property has been purchased using an SMSF loan.

   • Adding new rooms or structures

   • Renovating the kitchen or bathroom beyond basic repairs

   • Installing a swimming pool or extensive landscaping

   • Changing the overall layout or functionality of the property

However, if an SMSF utilises its existing funds (without using borrowed money) to pay for renovations or improvement, those renovations and improvement may be permissible, provided that the renovations are not deemed luxurious or excessive. Additionally, the SMSF must ensure compliance with rules regarding borrowing under a Limited Recourse Borrowing Arrangement, that is the SMSF would be restricted from borrowing additional funds to finance such renovations.

Repairs vs Improvement

We discussed that the extent of renovation or improvement is a primary factor in determining if it can be done to SMSF property. Then what are "repairs" and "renovations"?

“Repairs” are defined as necessary repairs to ensure the continued functioning of the property in its present state. Repairs includes maintenance to defects, deterioration or damage or reasonable actions to prevent them. For example, replacing an equivalent fence, or installing smoke detectors as per regulations, are seen as ‘repairs’.

“Renovations” are defined as making improvements that alter the property for the better to a significant degree, including adding features to the SMSF investment property. For example, adding a shed to the property is seen as a renovation.

As trustees of an SMSF, it is important to be cautious of potential breaches of the replacement asset clause within your SMSF. Such breaches could result in significant penalties if the improvements made to your SMSF property:

1. alter the property in such a way that the original function of the property is fundamentally changed (i.e. significant improvement that changes the asset to a "different asset"), or

2. the legal rights to the property change, such as in a sub division.

If you have further questions, please contact us (https://www.goodpca.com.au/contact-us).

Disclaimer

This content is intended as a general guide for GOOD PEOPLE ACCOUNTING SERVICES clients. The information is general in nature and does not take into account your personal situation. You should consider whether the information is appropriate to your needs, and where appropriate, seek professional advice. Although every effort has been made to verify the accuracy of the information contained above, GOOD PEOPLE ACCOUNTING SERVICES disclaim all liability (except for any liability which by law cannot be excluded), for any error, inaccuracy in, or omission from the information contained on this website or any loss or damage suffered by any person directly or indirectly through relying on this information.