From 10 August 2026, SMSFs will no longer be able to enter a new limited recourse borrowing arrangement over residential property. Existing arrangements are grandfathered, but the change adds a new layer to an area auditors already flag more than almost any other.
Many practitioners assume grandfathering means the ban simply doesn't touch their files. In practice, it changes what evidence auditors need to collect, and it lands on top of documentation and NALI risks that were already tripping funds up long before this reform.
We spoke with SMSF audit specialist Katrina Fletcher of Elite Super Pty Ltd about where LRBA audits are most likely to fail, and what the residential property ban means for audit files going forward.
Q: At a high level, what does the residential LRBA ban actually change for auditors?
A: The mechanics are simple: from 10 August 2026, a new LRBA over real property is only permitted if that property meets the business real property definition in section 66 of the SIS Act. Residential property no longer qualifies for a new arrangement.
For auditors, that means every LRBA settling after that date needs an extra question answered before anything else: what type of property is this, and can it be evidenced as business real property? That's a new audit step that didn't exist before.
Q: Does the ban affect LRBAs that are already in place?
A: No, and this is where I'd correct a common assumption. Existing arrangements are grandfathered, along with refinancing of pre-commencement borrowings, and acquisitions entered into before commencement even if settlement happens afterwards.
The practical risk isn't that these funds fall foul of the new rule. It's that auditors need to make and retain clear file notes establishing why an arrangement qualifies for grandfathering, and roll that conclusion forward every year so it doesn't need to be re-argued from scratch down the track.
Q: Business real property sounds like a straightforward test. Is it?
A: Not always. Up until now, that definition only mattered at the point of a related-party acquisition or lease. It's now become the gateway test for all future SMSF property borrowing, and it's a fairly technical test to apply to that purpose.
New commercial or industrial property that isn't yet leased to a business, for example, may struggle to meet the definition. Mixed-use premises are another grey area. Auditors should expect to need more evidence, not less, on any property purchase post-commencement.
Q: Setting the ban aside, where do LRBAs most commonly fail audit?
A: Documentation, more often than not. The bare trust deed can't be located, or relates to a different property. The loan agreement doesn't actually state the borrowing is limited in recourse. Sometimes the borrowing was structured over two separately titled assets rather than the single acquirable asset the law requires.
We also see funds using offset or redraw facilities on the LRBA loan, which raises real questions about whether the lender's recourse is genuinely limited to the secured asset. These are all issues that predate the ban entirely, and they remain the highest-frequency findings in any LRBA file.
Q: What about loans from related parties — is the risk different there?
A: Significantly higher. Related-party LRBAs need to meet the safe harbour terms in PCG 2016/5, covering interest rate, loan term, security and repayment structure, or the fund risks non-arm's length income applying to everything the asset produces.
The complication is that NALI isn't limited to the setup. If a related-party loan starts compliant and later drifts, say the interest rate isn't updated in line with the RBA benchmark, that's enough to trigger it too.
Q: If a related-party LRBA does come off the rails, can it be fixed?
A: This is the part that catches people out. The ATO's position is that once a related-party arrangement departs from the PCG requirements, the fund can't retroactively fix it and restore compliance. Making up missed or under-rate payments later doesn't undo the NALI exposure.
Refinancing onto arm's-length terms afterwards doesn't help either. The non-arm's length expenditure at acquisition or financing permanently taints the income from that asset, including any future capital gain on disposal.
Q: So what should auditors be doing right now to prepare for 10 August?
A: Build the extra property-type question into every LRBA audit program from that date, and don't assume it's obvious from the contract what category a property falls into. If it isn't clear, that's a request for further evidence, not an assumption in the trustee's favour.
For existing arrangements, make sure the grandfathering conclusion is documented properly in the permanent file and rolled forward each year, so a future auditor isn't left trying to reconstruct why an arrangement was accepted.
Keen to learn more?
Katrina Fletcher will present LRBAs Under the Microscope at the 14th Annual SMSF Audit Conference on 30 - 31 July 2026, covering audit documentation traps, the PCG 2016/5 safe harbour requirements, NALI risk under LCR 2021/2, and a full audit checklist for LRBAs under the new residential property rules.
