The Fine Line Between a Tax-Deductible Repair and an Illegal Fund Breach
One of the most common questions trustees ask after acquiring an investment property inside super is: 'Can we renovate the bathroom, install solar panels, or add a granny flat in the backyard to increase the rental yield?'
Under personal property investing, you can renovate, extend, or demolish properties whenever you like. Inside an SMSF with an active LRBA loan, the ATO enforces strict, non-negotiable restrictions under ruling SMSFR 2012/1.
The critical distinction is between 'Repairs and Maintenance' (which can be funded using borrowed money or fund cash) versus 'Improvements' (which can only be funded using existing fund cash, never borrowed money, and cannot change the fundamental character of the asset).
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| Renovation Activity | Classification | Funding Source Allowed | Legal Under Active LRBA? |
|---|---|---|---|
| Fixing Broken Roof Tiles / Plumbing | Repair & Maintenance | Borrowed Funds or Cash | ✅ 100% Legal |
| Repainting & Modernizing Kitchen Cabinets | Repair / Like-for-Like | Borrowed Funds or Cash | ✅ 100% Legal |
| Adding a Second Storey / Extension | Substantial Improvement | Existing Cash Only (No Loan) | ✅ Legal if Not Different Asset |
| Converting House to Commercial Offices | Different Asset Transformation | Prohibited | ❌ Illegal Breach of s 67A |
| Building a Granny Flat for Separate Rent | Subdivision / New Asset | Prohibited | ❌ Illegal while LRBA Active |
1. What is the Difference Between a Repair and an Improvement?
According to the ATO, a 'repair' restores an asset to its original functional efficiency without significantly changing its character (e.g., replacing a rotted timber floor with modern hybrid tiles, repairing damaged gutters, or replacing a broken air conditioner).
An 'improvement' significantly increases the value, efficiency, or capacity of the asset beyond its original state (e.g., adding an inground pool, building a deck, or adding an extra bedroom).
2. How to Fund Allowable Renovations
If you wish to carry out allowable improvements on an SMSF property, the funding must follow strict rules:
- Must Use Available SMSF Cash: All improvement costs must be paid directly from the super fund's accumulated cash reserves or contributions.
- Never Use Borrowed Money: You cannot draw down on the mortgage or take an equity loan to pay for renovations.
- No Personal 'Sweat Equity': Fund members cannot carry out unpaid manual building work on the property (doing so breaches the arm's-length and contribution rules).
3. What Happens Once the Loan is Fully Paid Off?
Once the SMSF mortgage is completely repaid and the Bare Trust is discharged, the Section 67A restrictions completely disappear.
The SMSF is then free to renovate, redevelop, or transform the property using its cash reserves, provided the investment strategy complies with general SIS Act regulations.
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David Chi Tran
Emerge Finance
Frequently Asked Questions: Repairs vs Improvements in SMSF: What Alterations Are Legal Under an LRBA
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