What happens to a bare trust in a failed property purchase?
When a self-managed super fund (SMSF) decides to purchase a property using borrowings under a bare trust otherwise known as a limited recourse borrowing arrangement (LRBA) the legal title must be held on trust for the SMSF. In other words, the property is not owned by the SMSF trustee but is held in a trust with the beneficial owner being the SMSF.
The type of trusts that satisfies the SIS legislation and widely used by SMSFs include a bare trust, holding trust or a custodian trust. All of these trusts are very similar in how they operate. In this article we are talking about a bare trust.
The Superannuation Industry (Supervision) Act 1993 (SIS) at Section 67A does not specify what type of trust but requires the trust to:
- hold the property title on behalf of the SMSF who acquires the beneficial interest in the property – this merely means the SMSF has all rights to the property and receives rental income and is responsible for paying property expenses and to ensure the property is maintained. The SMSF does not have legal ownership and therefore the title is held in the name of the bare trust and/or the bare trustee
- the SMSF trustee has the right to acquire the legal title after the loan has been repaid – there is no legal requirement that the bare trustee must transfer the title back to the SMSF trustee but must be transferred if the SMSF trustee requests it, but the LRBA rules remain in place until the transfer takes place
What is a bare trust?
There must be a property, a trustee and a beneficiary. A bare trust is a trust arrangement where the bare trustee holds property on behalf of a beneficiary. The bare trustee does nothing other than hold the title of the fund’s property. It has no discretion and has no other assets or liabilities; it does not have to be registered for GST or receive income or pay expenses or prepare and lodge tax returns. All bare trust expenses are paid by the SMSF. It must do the bidding of the SMSF trustee.
Can my SMSF reuse the bare trust?
It will depend on the law firm providing the bare trust and the stamping rules relevant to the state you are in. The deed may need to be amended for details of the new property. However, a corporate trustee can always be reused for future LRBAs and in 99% of cases our firm has been able to reuse the Bare Trust Deed without additional cost to the trustees.
Closing a bare trust when the property purchase failed
The other option is that an SMSF can choose to close down a bare trust if the property purchase fails. This tends to happen if the bare trust was established with only one purpose which was to acquire property on behalf of the SMSF. As there is no asset there is no trust.
Winding up the trust deed is very simple. The trust was not activated and no LRBA was established.
The actions that can be taken include:
- where the bare trust documents are drafted but not executed nothing exists so the documentation can be disregarded (or reused for the next purchase as mentioned above).
- where the bare trust documents were executed, best practice is to minute the trust being wound up and keep that on file with a copy of the bare trust documentation
- consider what happens to the bare trustee if it is a company – decide if you want to deregister the company which can incur a small ASIC voluntary deregistration fee or keep the company which can be used for a future LRBA or for another purpose, but annual ASIC fees will continue to apply
How does my SMSF treat the set up and wind-up costs of the bare trust and corporate trustee?
An SMSF treats the establishment cost of a bare trust and bare trust trustee as capital costs which are not deductible to an SMSF. The expenses can form part of the cost base of the property. Since they’re part of the LRBA and not considered borrowing expenses, they aren’t deductible over five years. However, if the property purchase fails the costs are written off as a non-deductible “blackhole expense”, which SMSFs cannot claim because they typically don’t carry on a business.