Avoid These 5 Mistakes with SMSF Commercial Leasebacks

An SMSF commercial leaseback can be a structured way to build wealth in your superannuation fund while your operating business pays deductible rent. The fund acquires commercial property, your related business becomes the tenant, and the arrangement needs to meet every condition under superannuation law or risk severe penalties.

Mistake 1: Assuming Residential Property Is Still an Option

From approximately 10 August 2026, new limited recourse borrowing arrangements can only be used to acquire real property that satisfies the definition of business real property under section 66 of the SIS Act. Residential property does not meet that definition. The prohibition applies to all new contracts exchanged after the operative date, regardless of whether the property is newly constructed or established.

Consider a Lang Lang business owner who planned to use super to buy a rental dwelling in Grantville and lease it to family members. That structure is no longer viable under a borrowing arrangement. SMSFs may still acquire residential property using existing fund assets without borrowing, but the property cannot be occupied by a fund member or related party, eliminating the leaseback option entirely for residential assets.

LRBAs for commercial property that satisfies the definition of business real property under section 66 of the SIS Act are not affected by the 2026 residential ban. Commercial leasebacks remain compliant where the property is used wholly and exclusively in one or more businesses.

Mistake 2: Leasing Property That Does Not Qualify as Business Real Property

Business real property means land and buildings used wholly and exclusively in one or more businesses. Where the property contains a dwelling for private or domestic purposes, it can still qualify if the dwelling occupies no more than 2 hectares and the main use of the whole property is not domestic or private.

A warehouse in the Lang Lang industrial precinct used solely for storage, packing, or distribution qualifies without issue. A mixed-use property where a family lives above a shopfront may not qualify if the main use is residential. The classification depends on actual use at the time of acquisition, not the intended use after settlement.

Vacant land presents a particular challenge. Whether a property satisfies the business real property definition depends on its actual use at the time of acquisition. Vacant land not currently used in a business and mixed-use properties where the main use is domestic or private may not qualify. If your fund intends to acquire vacant land through a Limited Recourse Borrowing Arrangement and construct a commercial building, confirm with an SMSF specialist that the vacant land itself can be classified as business real property before proceeding.

Mistake 3: Structuring the Lease on Non-Commercial Terms

Business real property leased between the fund and a related party of the fund is excluded from the in-house asset rules. Any such lease must be made on arm's length terms at market value. The ATO expects a formal written lease, market rent supported by independent valuation, and a rent review mechanism consistent with comparable commercial leases in the area.

In a scenario where a Lang Lang earthmoving business leases a depot and workshop from the owner's SMSF, the rent must reflect what an unrelated tenant would pay for the same premises. Charging below-market rent to reduce operating expenses in the business triggers non-arm's length income provisions, and the rental income received by the fund may be taxed at the highest marginal rate rather than the concessional superannuation rate.

The lease term, outgoings, maintenance obligations, and rent escalation clauses must all reflect commercial practice. A peppercorn rent, informal payment arrangement, or lease without independent documentation will not satisfy compliance requirements. Many lenders offering SMSF loans require sight of the lease agreement as part of the approval process and will assess whether terms are consistent with market norms.

Mistake 4: Using Borrowed Funds to Improve the Property After Settlement

Borrowed funds cannot be used to improve an existing asset. An existing fund asset cannot be placed into an LRBA. Drawdowns for capital improvements are not permitted for LRBAs entered into on or after 7 July 2010. The loan can only be used to acquire the property and cover associated costs such as stamp duty and establishment fees.

Suppose your fund borrows to acquire a small commercial building on the South Gippsland Highway. After settlement, the business needs roller doors replaced and a mezzanine office installed. Those improvements must be funded from the SMSF's existing cash reserves or future rental income, not from borrowed funds. Attempting to draw down additional loan funds for capital works breaches the borrowing conditions and could cause the entire arrangement to fail.

Any capital improvements funded by the SMSF must be documented separately from the loan. This restriction limits the flexibility of the structure and requires disciplined cashflow planning within the fund to ensure sufficient liquidity for maintenance, improvements, and loan servicing.

Mistake 5: Overlooking the Total Superannuation Balance Impact on Division 296 Tax

From 1 July 2026, where a member's total superannuation balance (TSB) at the end of the financial year exceeds the large super balance threshold of $3 million, Division 296 tax of 15 percent applies to the proportion of earnings attributable to the amount above the threshold. Where the TSB exceeds the very large super balance threshold of $10 million, an additional 10 percent Division 296 tax applies to the proportion of earnings above that threshold.

Outstanding LRBA amounts entered into on or after 1 July 2018 are included in a member's TSB in certain circumstances, including where the LRBA is with an associate of the fund or where the member has satisfied a condition of release with a nil cashing restriction. If your SMSF borrows from a related party to acquire commercial property, the outstanding loan amount may inflate your TSB and push you over the threshold even though the borrowed amount does not represent actual member contributions or accumulated earnings.

In our experience, members approaching the $3 million threshold often overlook the impact of related party LRBAs on their TSB calculation. A commercial property acquisition involving a related party loan of $800,000 could trigger Division 296 tax on a member whose actual accumulated benefits would otherwise fall below the threshold. Where borrowing from an unrelated lender is an option, the TSB treatment may differ and should be modelled carefully before settlement.

The interaction between Division 296 tax and LRBAs is complex and depends on the specific structure of the borrowing arrangement, the member's age, and whether a condition of release has been met. Seek advice from a licensed SMSF specialist before finalising any related party loan.

Refinancing and the Risk of Creating a New Arrangement

The Treasury Laws Amendment (Tax Reform No. 1) Act 2026 provides that the residential LRBA prohibition does not apply to maintaining or refinancing a borrowing under an arrangement entered into before the commencement date. Commercial LRBAs are not affected by the residential ban and can be refinanced without triggering the new restrictions.

Under the ATO's existing position, a significant change to the terms or conditions of an LRBA ends the arrangement and a new one begins. Circumstances that may end an existing arrangement include refinancing that is inconsistent with the original arrangement, borrowing to acquire an asset not contemplated under the original arrangement, and changes to the ultimate beneficiaries of the arrangement.

If your SMSF currently holds a commercial property under an LRBA and you refinance to a different lender, the arrangement will generally remain compliant provided the refinanced loan relates to the same property, maintains limited recourse character, and meets arm's length terms. Refinancing that involves additional borrowing to fund capital improvements or a change in the asset being acquired may constitute a new arrangement and breach the single asset rule.

If you are considering refinancing an existing commercial loan held within your SMSF, document the continuity between the original and refinanced arrangements and obtain confirmation from your SMSF auditor that the refinancing does not trigger a new LRBA.

Call one of our team or book an appointment at a time that works for you to discuss whether an SMSF commercial leaseback structure suits your circumstances and how to structure the arrangement to meet compliance requirements from the outset.

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