Single Asset

The Draft Ruling takes the position that the meaning of “asset” should be given, in certain situations, a practicable meaning rather than a purely legal meaning.  Normally, “asset” will be taken as having the sense of “legal title”.  However, “asset” will be taken as consisting of 2 or more legal titles where these titles are linked: either legally or physically.

If a vendor wishes to sell one 2 acre block which consists of two titles, there will be two assets for the purposes of limited recourse borrowing rules.  However, if there is a structure which sits on both titles (thus physically linking to the two titles), so that it is not practicable to sell each title separately, then the Draft Ruling provides that there is a single asset.

Another example is where there are two titles but those titles must by law be sold together.  In this case, the link between the two titles is a legal link.

Where the vendor insists on selling two or more titles as a job lot, the vendor’s insistence will not be a sufficient link.  Equally, a lender’s requirement that a mortgage be taken over all titles will not be a sufficient link.

Repairing, Maintaining & Improving

The limited recourse borrowing rules (at least since July 2010) permit the SMSF Trustee to use borrowed funds to repair and maintain assets.  However, these rules will not permit the SMSF Trustee to improve the asset thereby transforming the asset into a different asset.

It is not necessarily easy to distinguish between repairing and improving an asset.

In relation to “maintaining” an asset, the Draft Ruling provides that this term means work done to prevent defects, damage or deterioration of an asset.

The Draft Ruling provides that “repairing” is usually the restoration of an asset to regain the asset’s previous functional efficiency.

Improving an asset is by contrast to substantially increase its functional efficiency or value through the addition of new and substantial features or bringing the asset into a more desirable form, state or condition.  In short, improvements are matters of degree.  A minor increase in functional efficiency or value will not amount to an improvement.

The Draft Ruling provides a number of examples where changes are merely repairs as against improvements (and vice versa).

Applying the Draft Ruling the following are likely to be repairs

• Replacing a damaged kitchen with a new kitchen
• Replacing roofing with new roofing
• Painting the exterior of a house
• Resurfacing a swimming pool

The following are likely to be improvements and thereby transform the existing asset into a different asset

• Adding a second storey to a single storey residence
• Adding a swimming pool
• Adding one or more rooms

Clearly changes which are repairs do not cease to be repairs because modern materials are used or the changes are made to conform to current building standards – replacement of concrete tiles with ceramic titles or steel roofing.

Also, it seems updating a kitchen or bathroom would not be material improvements – as the increase in the cost of the underlying asset is not necessarily significant and there is no increase in functionality.

Further it seems that a series of discrete improvements made over an extended time period will not amount to a material improvement.

The interesting question is whether replacing an existing house with a new house on the same block amounts to sufficient improvement to constitute a transformed asset.  Possibly replacing an existing house with a modern house with the same number of bedrooms and living areas may not constitute a transformed asset.  The Draft Ruling does accept that replacing a house completely destroyed by fire (or flood etc) with an equivalent house (ie with the same functionality) will not constitute a transformed asset.  It would be irrelevant that modern building materials are used (and the new structure satisfies modern building standards as to energy efficiency, building materials).

Adding additional bedrooms or adding a swimming pool may be too much and the new house may constitute a transformed asset.  If a replacement house (with equivalent functionality) will not constitute a transformed asset then it seems irrelevant that the reason for the building of the replacement house is fire, destruction or owner’s choice.  The reason that the replacement house is not a transformed asset is that there is no change in functionality: there is no exception for houses destroyed by fire or flood in the legislation.