Top Strategies to Transition Your SMSF Loan to Pension

Moving from Accumulation to Pension with Property in Your SMSF

Transitioning an SMSF loan from accumulation to pension phase doesn't change the loan itself, but it shifts how rental income and capital gains are taxed and which assets can support your retirement income stream. The decision affects whether you'll pay tax on property income at 15 percent, qualify for exempt current pension income, or trigger Division 296 tax if your total superannuation balance sits above $3 million.

Schofields residents with SMSF property often hold commercial real estate or residential property acquired before the August restrictions. The distinction matters because commercial property held under a Limited Recourse Borrowing Arrangement can still be acquired with borrowed funds, while new residential LRBAs are no longer permitted for arrangements entered into after 10 August 2026. If you're holding property acquired before that date, refinancing remains an option without triggering the new rules.

When you move a property-backed SMSF into pension phase, the loan continues under the same terms. The holding trust structure remains in place until the loan is repaid and legal ownership transfers to the SMSF trustee. What shifts is the tax treatment of rental income and any capital gain on disposal, depending on whether the asset is segregated as a current pension asset or proportioned between accumulation and pension interests.

What Happens to Rental Income When You Start a Pension

Rental income from an SMSF property is taxed at 15 percent during accumulation phase. Once you commence a pension and the property supports a retirement-phase income stream, that income may qualify for exempt current pension income, which means no tax is payable on it.

Where all fund assets are segregated as current pension assets for the entire income year, rental income is fully exempt. From the 2022 financial year onward, if all of a fund's assets are paying retirement phase pension benefits at all times during the year, those assets are automatically regarded as segregated current pension assets. If the fund holds both accumulation and pension interests, the exemption applies only to the proportion determined by an actuarial certificate, and rental income from the non-exempt portion remains taxable at 15 percent.

Consider a Schofields SMSF trustee who holds a small commercial warehouse on Windsor Road under an LRBA established several years ago. The property generates $28,000 in annual rent. During accumulation, the fund pays $4,200 in tax on that income at 15 percent. After the member starts a pension and segregates the property as a current pension asset, the rental income becomes fully exempt, provided minimum pension payments are met and the fund satisfies all other pension conditions. The loan repayments continue from the fund's cash flow, which now includes the after-tax rental income and any other fund earnings.

Tax Treatment of Capital Gains on Disposal in Pension Phase

A capital gain on the sale of SMSF property is not automatically tax-free just because the fund is paying a pension. The exemption depends on whether the asset was segregated as a current pension asset at all times during the income year of disposal, or whether the proportionate method applies.

Where a property is fully segregated, the capital gain is disregarded entirely. Where the fund uses the proportionate method, the exemption applies only to the proportion of the net capital gain attributable to pension interests, as determined by an actuarial certificate. The remaining portion is taxed at 15 percent, with a one-third discount available if the property was held for at least 12 months, producing a maximum effective rate of 10 percent on the discounted portion.

The actual tax liability varies depending on the property's adjusted cost base, acquisition and selling costs, capital improvements, capital works deductions, capital losses, and the fund's overall tax position for that year. Capital losses cannot be claimed against income and can only offset capital gains. Where capital losses exceed capital gains in a financial year, the net capital loss is carried forward.

If you sell a property that was held in accumulation phase for part of the ownership period and pension phase for another part, the proportionate method determines how much of the gain is exempt. An actuarial certificate calculates the exempt proportion based on the number of days the asset supported pension interests relative to total fund assets. This can produce a partial exemption even where the fund is fully in pension phase at the time of sale, if it was in accumulation phase for part of the holding period.

Division 296 Tax and Property Held Under an LRBA

From 1 July 2026, members with a total superannuation balance exceeding $3 million at the end of the financial year are subject to Division 296 tax of 15 percent on the proportion of earnings attributable to the amount above that threshold. An additional 10 percent applies to the portion above $10 million. Both thresholds are subject to indexation in subsequent years.

For SMSF purposes, Division 296 fund earnings are an adjusted amount of the fund's taxable income. A capital gain must be realised through a CGT event for it to form part of the fund's assessable income and the Division 296 earnings base. An unrealised increase in property value does not constitute a CGT event and does not by itself produce assessable income or Division 296 fund earnings. Rental income and realised capital gains may contribute to the Division 296 calculation.

LRBA amounts are disregarded when calculating a member's total superannuation balance for Division 296 tax purposes. If your SMSF holds a commercial property under an LRBA with an outstanding loan balance of $400,000, that amount is excluded from the total superannuation balance calculation. The property's market value, minus the loan balance, is included in the balance. This can provide some relief for members with large property holdings and significant borrowings.

An SMSF may elect to adjust the cost base of its CGT assets to market value as at 30 June 2026 for Division 296 fund earnings purposes. This election recognises accrued value prior to the commencement of Division 296 tax. The election applies to all CGT assets held directly by the SMSF at 30 June 2026, cannot be revoked, and must be made by the due date of the 2026-27 SMSF annual return. Members do not need to be over the threshold for the fund to make this election. Division 296 tax assessments for the 2026-27 income year are expected to begin issuing in the second half of the 2027-28 income year.

Refinancing an Existing SMSF Loan After Transition

Refinancing an SMSF loan does not change whether the property can support a pension, but it does require care to maintain compliance with the LRBA conditions and avoid inadvertently ending the arrangement.

The changes commencing 10 August 2026 do not impact the refinancing of arrangements existing prior to that date. The ATO considers refinancing an LRBA to mean entering into a new loan contract for the same asset, with the same or a new lender. Trustees with compliant residential or commercial LRBAs in place before 10 August 2026 can refinance to another lender without the refinanced arrangement being subject to the post-commencement rules.

A significant change to the terms or conditions of an LRBA can end the existing arrangement and start a new one. 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. A new arrangement entered into on or after 10 August 2026 that involves residential property would be subject to the post-commencement rules and could not proceed.

Consider a Schofields SMSF trustee who holds a residential investment property on Railway Terrace under an LRBA established in early 2025. The member transitions to pension phase and wants to refinance to a lower rate. Provided the refinanced loan relates to the same property, maintains the limited recourse character of the original arrangement, and meets arm's length terms, the refinancing can proceed without triggering the new residential LRBA restrictions. The property can continue to support the pension, and any rental income remains eligible for ECPI treatment where the asset is segregated.

For related party loans, the interest rate must meet the ATO's safe harbour rates published under Practical Compliance Guideline PCG 2016/5, updated annually. Income from an arrangement that does not meet arm's length terms may be assessed as non-arm's length income and taxed at 45 percent. Genuine offset accounts offered by an authorised deposit-taking institution are not treated as a borrowing or a charge over fund assets under existing ATO guidance.

Contribution Caps and Transfer Balance Cap on Transition

Moving to pension phase requires the member to have met a condition of release, typically retirement or reaching preservation age with a transition to retirement income stream. The general transfer balance cap increased from $2 million to $2.1 million on 1 July 2026. Members commencing a pension for the first time on or after 1 July 2026 have a personal transfer balance cap of $2.1 million.

The value credited to the transfer balance account is the amount used to commence the pension, not the market value of underlying assets. Where an SMSF holds property under an LRBA, the loan balance does not reduce the transfer balance cap credit. If your SMSF has a total value of $1.8 million and you commence a pension using the full balance, $1.8 million is credited to your transfer balance account, even if the fund holds a property with an outstanding loan.

Contributions can still be made during pension phase, subject to caps. The concessional contributions cap is $32,500 per annum from 1 July 2026. The non-concessional contributions cap is $130,000 per annum. The bring-forward arrangement allows non-concessional contributions of up to $390,000 over three years where the member's total superannuation balance on 30 June of the previous year was below $1.84 million. Where the balance was between $1.84 million and $1.97 million, the bring-forward cap is $260,000 over two years. Where the balance was between $1.97 million and $2.1 million, only the annual cap of $130,000 applies. Where the balance equalled or exceeded $2.1 million, the non-concessional contributions cap is nil.

For Schofields residents with SMSF property, understanding how the loan balance, property value, and transfer balance cap interact is part of the transition planning. If you intend to make further contributions, the timing of the pension commencement relative to your total superannuation balance on 30 June determines your available caps. Refinancing the SMSF loan before or after transition does not change these caps, but it can affect cash flow and the fund's ability to meet minimum pension payment requirements.

Sole Purpose Test and Related Party Leasing During Pension Phase

All SMSF investments, including property held under an LRBA, must be maintained at all times for the sole purpose of providing retirement benefits for SMSF members. Decisions that give members or related parties a present-day benefit may contravene section 62 of the SIS Act, regardless of whether the fund is in accumulation or pension phase.

Where an SMSF holds commercial property that satisfies the definition of business real property under section 66 of the SIS Act, the property can be leased to a related party on arm's length terms at market value. Business real property generally means land and buildings used wholly and exclusively in one or more businesses. The business does not need to be carried on by the entity holding the interest in the property. Whether a property satisfies the definition depends on its actual use at the time of acquisition and is a question of fact.

A Schofields SMSF trustee who holds a small industrial unit on an LRBA and leases it to a family business must ensure the lease is on arm's length terms, the rent is at market value, and the arrangement does not provide a present-day benefit that conflicts with the sole purpose test. This applies whether the fund is in accumulation or pension phase. Where the lease is not on arm's length terms, rental income may be assessed as non-arm's length income and taxed at 45 percent, and the arrangement may breach the sole purpose test.

Residential property held in an SMSF cannot be leased to a member or a related party of a member at any time, whether the fund is in accumulation or pension phase. The property must be leased to an unrelated third party on commercial terms. This restriction applies to all residential property held in an SMSF, regardless of whether it was acquired under an LRBA or purchased outright.

Quick Mortgage works with Schofields clients who hold SMSF property and are planning the transition to pension phase. We compare SMSF lenders for refinancing, confirm the LRBA conditions are maintained, and coordinate with your SMSF specialist to ensure the loan structure supports your retirement income stream. Call one of our team or book an appointment at a time that works for you.

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