When to Renovate vs Replace Under an SMSF Loan

SMSF Loans & Capital Works: What You Can't Do With Borrowed Money

Borrowed funds under a Limited Recourse Borrowing Arrangement cannot be used to improve an existing asset held in your self-managed super fund. This restriction applies whether you're holding residential property acquired before the August 2026 ban or commercial property purchased through your SMSF. The borrowed amount must be used only to acquire the asset and cover direct acquisition costs such as stamp duty and loan establishment fees.

The restriction exists because the LRBA legislation requires the borrowed money to acquire a single asset. Any improvement changes the nature of that asset, which falls outside the scope of what the arrangement permits under sections 67A and 67B of the Superannuation Industry (Supervision) Act. Fund cash can be used for improvements, but not borrowed money.

For SMSF trustees in Slacks Creek considering commercial property loans or managing existing residential holdings, this creates a planning challenge. You need to decide upfront whether the property will generate sufficient rental income without capital works, or whether you'll need fund reserves to finance improvements later.

Drawdowns for Capital Improvements Are Not Permitted

Any LRBA entered into on or after 7 July 2010 prohibits additional drawdowns for capital improvements. This means you cannot increase the loan amount or draw down unused funds to renovate, extend, or upgrade the property after settlement. Even if the lender offers a redraw facility on the loan account, using it for capital works would breach the LRBA conditions and potentially expose your fund to compliance penalties.

Consider a trustee who purchases a warehouse in Kingston through an SMSF commercial loan and settles with a loan balance of $450,000. Twelve months later, the tenant requests upgraded roller doors and loading docks to extend their lease for another five years. The trustee cannot redraw funds or refinance to a higher loan amount to fund those works. The fund must use existing cash reserves or accumulate rental income over time to pay for the upgrades.

Where fund liquidity is limited, the trustee faces a choice: decline the tenant's request and risk losing the lease, or delay the works until sufficient cash accumulates in the fund. This is why cash flow planning before acquisition matters. SMSF loans require you to model not only the loan serviceability from rental income but also the fund's capacity to meet ongoing capital expenditure without access to borrowed funds.

What Qualifies as an Improvement Under LRBA Rules

An improvement is any work that enhances the value, functionality, or capacity of the property beyond its condition at the time of acquisition. Structural extensions, additional buildings, upgraded fixtures, landscaping, and reconfiguration of internal spaces all fall into this category. Repairs and maintenance that restore the property to its original condition are not improvements, but determining the boundary between repair and improvement is not always straightforward.

The Australian Taxation Office applies a substance-over-form test. Replacing a damaged roof with identical materials is maintenance. Replacing a tiled roof with a metal roof that increases property value or rental appeal is an improvement. Repainting in the same colour is maintenance. Repainting and adding built-in cabinetry is improvement. The test is whether the work results in a better asset than what the fund originally acquired.

In practice, most trustees take a conservative approach. If the work could be argued either way, they fund it from the SMSF's cash reserves rather than risk a breach. Given that non-arm's length income is taxed at the highest marginal rate and compliance failures can result in the fund losing its complying status, the risk of using borrowed funds incorrectly is significant.

Using Fund Cash for Capital Works on LRBA Property

Your SMSF can use existing fund cash to improve property held under an LRBA. The restriction applies only to borrowed money, not to funds already held by the SMSF from member contributions, rollovers, or accumulated income. This distinction is central to how you structure your fund's cash flow and contribution strategy.

A trustee holding a commercial premises in the Slacks Creek industrial precinct under an LRBA might plan to carry out minor fit-out works after settlement to attract a higher-quality tenant. Those works must be funded from the SMSF's cash balance. If the fund balance is insufficient, the trustee can make additional concessional or non-concessional contributions within the relevant caps and use those contributed funds for the capital works.

From 1 July 2026, the concessional contributions cap is $32,500 per annum and the non-concessional cap is $130,000 per annum. Members with a total superannuation balance below $1.84 million on 30 June of the previous year may access the bring-forward arrangement, allowing non-concessional contributions of up to $390,000 over three years. Where planned capital works exceed available fund cash, contribution planning becomes part of the SMSF loan application process.

Refinancing After Capital Works: When Does the Arrangement End?

Refinancing an existing LRBA to a higher loan amount after using fund cash to improve the property may create a new arrangement, which would then be subject to current legislative conditions. As at early July 2026, the ATO had not published updated guidance on how refinancing will be treated under the post-commencement residential ban, but existing guidance under Practical Compliance Guideline PCG 2016/5 indicates that a significant change to the terms or conditions of an LRBA ends the original arrangement.

If you refinance to extract equity created by capital improvements funded from SMSF cash, the ATO may treat that refinancing as a new borrowing. For residential property, any new LRBA entered into after approximately 10 August 2026 is prohibited. For commercial property, a new arrangement would need to satisfy all current compliance conditions, including that the borrowed funds are used to acquire a single asset. Extracting equity does not meet that requirement.

This creates a permanent constraint for residential LRBA properties acquired before the ban. You can improve them using fund cash, but you cannot later refinance to access that improved equity without potentially ending the grandfathered status of the arrangement. For commercial property, the same constraint applies, though the prohibition is based on compliance conditions rather than a legislative ban. Trustees considering capital works on LRBA property should work with an SMSF mortgage broker and an SMSF specialist accountant to model the long-term impact on the fund's borrowing capacity and liquidity.

Commercial Property and the Business Real Property Test

Commercial property acquired under an LRBA must meet the business real property definition in section 66 of the SIS Act both at the time of acquisition and on an ongoing basis. Business real property means land and buildings used wholly and exclusively in one or more businesses. If capital works funded by the SMSF change the use of the property such that it no longer qualifies, the fund may breach the in-house asset rules or related party acquisition rules if a related party is involved.

A property used wholly for warehousing and logistics qualifies. If the trustee later uses fund cash to construct an on-site dwelling for a caretaker and that dwelling occupies more than two hectares or becomes the main use of the property, the property may no longer meet the definition. The ATO's guidance in SMSFR 2009/1 provides detailed examples, but the practical point is that capital works must be assessed not only for LRBA compliance but also for their effect on the property's classification.

For Slacks Creek SMSF trustees, this matters particularly in mixed-use developments or properties on larger parcels where future development potential might include residential components. The decision to carry out capital works should include advice on whether the completed works will maintain the property's status as business real property.

Planning Before You Borrow: How to Avoid Cash Flow Constraints

The most reliable way to manage capital works restrictions is to plan for them before you enter the LRBA. Model the rental income, loan serviceability, and likely capital expenditure over a ten-year period. Include a buffer for unplanned maintenance and a separate allocation for planned improvements. If the fund cannot meet those requirements from accumulated rental income and scheduled member contributions, the property may not be suitable for acquisition under a limited recourse borrowing arrangement.

Where the property is commercial and the tenant is a related party of the fund, lease terms must be at arm's length. This includes responsibility for repairs and capital works. A lease that pushes all capital expenditure onto the landlord without a corresponding rental adjustment may not satisfy arm's length conditions, particularly where the tenant is a related party business. The lease structure should reflect what an independent landlord and tenant would agree in the open market.

Working with a broker who understands the interaction between loan structure, fund cash flow, and LRBA compliance conditions means you can structure the acquisition to allow for future works without relying on prohibited drawdowns or refinancing. Call one of our team or book an appointment at a time that works for you.

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