SMSF Pension Transitions & Property Loans

When You Start a Pension, the SMSF Loan Stays the Same

Transitioning to pension phase does not require you to repay or restructure your SMSF property loan. The loan remains in place under the same limited recourse borrowing arrangement (LRBA), and the property continues to be held in the same holding trust. What changes is how the rental income and capital gains from that property are taxed, depending on whether the asset is supporting a pension or remains in accumulation.

The decision about how much of your fund to allocate to pension phase affects the tax treatment of the property's returns. If your SMSF holds both accumulation and pension interests, the tax exemption available in pension phase applies only to the proportion of income and gains attributable to pension assets. This proportionate treatment can become complex where a single property supports both phases, particularly in the years surrounding a member's transition.

For Central Coast residents holding commercial or residential SMSF property and approaching retirement, understanding how the capital gains tax position shifts is particularly relevant. Property values across the region have moved substantially over the past decade, and the timing of a sale relative to pension commencement can materially affect the after-tax outcome.

How Capital Gains Tax Works in Pension Phase

A capital gain is not automatically tax-free because an SMSF has commenced a pension. The tax treatment depends on whether the fund's assets are fully segregated to support pensions, or whether the fund uses the proportionate method to calculate exempt current pension income (ECPI).

Where a fund's assets are fully segregated as current pension assets at all times during the income year, a capital gain on disposal of those assets is disregarded. From the 2022 financial year, where all of a fund's assets are paying retirement phase pension benefits at all times of the year, the fund's assets are regarded as segregated current pension assets.

Where the fund uses the proportionate method, the exemption applies only to the exempt proportion of the net capital gain, as determined by an actuarial certificate.

Consider a Central Coast SMSF trustee who holds a warehouse in Somersby under an LRBA. The property was acquired several years ago and has appreciated. The member starts an account-based pension in July and allocates $1.8 million of the fund's $2.2 million balance to pension phase. The remaining $400,000 stays in accumulation. If the warehouse is sold later that financial year, the capital gain is only partially exempt. The actuarial percentage determines how much of the gain is tax-free and how much is taxed at up to 10 percent (after applying the one-third CGT discount for assets held longer than 12 months).

If the same member had fully transitioned to pension phase before the sale, and the fund held no accumulation interests at any point during that income year, the entire capital gain would be disregarded.

Segregation vs Proportionate Method: What It Means for Your Property

Segregation means the fund's assets are entirely designated to support retirement phase pensions. Where a fund's assets are fully segregated as current pension assets at all times during the income year, a capital gain on disposal of those assets is disregarded. This requires that no member retains an accumulation balance and that the fund does not accept new contributions during the year (or manages them carefully to maintain full segregation).

The proportionate method applies where the fund has both pension and accumulation interests. The ECPI exemption is calculated based on the proportion of the fund's liabilities that relate to pension accounts, certified by an actuary. This proportion is applied to all investment income, including realised capital gains.

A fund using the proportionate method cannot choose to designate specific assets to pension or accumulation. The exemption applies proportionally across all income and gains. Where a property is sold, the capital gain is split between exempt and taxable components according to the actuarial percentage, regardless of which member's balance contributed to the property's purchase.

For members approaching pension age, this distinction matters when deciding whether to fully transition or maintain a partial accumulation balance. Retaining even a small accumulation interest means the fund cannot access full segregation, and an actuarial certificate will be required to determine the exempt proportion of any capital gain.

Division 296 Tax and Unrealised Property Gains

From 1 July 2026, where a member's total superannuation balance (TSB) at the end of the financial year exceeds the large super balance threshold (LSBT) of $3 million, Division 296 tax of 15 percent applies to the proportion of earnings attributable to the amount above the LSBT. Where the TSB exceeds the very large super balance threshold (VLSBT) of $10 million, an additional 10 percent Division 296 tax applies to the proportion of earnings above that threshold.

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 therefore the Division 296 earnings base. An increase in property value does not by itself trigger Division 296 tax unless the property is sold or another CGT event occurs.

LRBA amounts are disregarded when calculating a member's TSB for Division 296 tax purposes. If a member's SMSF holds a commercial property under an LRBA with an outstanding loan, the value of the property is included in the TSB, but the loan liability is deducted. Only the net equity is counted.

For Central Coast members holding appreciated commercial property in areas like Erina or West Gosford, this creates a potential tax planning consideration. Selling before or after transition to pension phase will produce different outcomes depending on whether the member is over the relevant thresholds and whether the fund is fully segregated at the time of sale.

Refinancing an Existing SMSF Loan After Transition

The changes commencing 10 August 2026 do not impact the refinancing of arrangements existing prior to that date. If your SMSF established a residential or commercial property loan before that date, you can refinance to another lender without the new rules affecting the arrangement.

Transitioning to pension phase does not change your ability to refinance. The loan remains a liability of the SMSF, not of any individual member account. Lenders assess the fund's capacity to service the loan based on rental income and any other fund income, regardless of whether members are drawing pensions.

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. The refinanced loan must relate to the same property held in the original holding trust, maintain the limited recourse character, and meet arm's length terms.

The ATO publishes safe harbour interest rates for SMSF LRBAs under Practical Compliance Guideline PCG 2016/5, updated annually, applying to both real property and listed securities. Where a related party is the lender, the interest rate must meet these benchmarks. If the rate does not satisfy arm's length conditions, income from the arrangement may be assessed as non-arm's length income and taxed at 45 percent.

Refinancing to secure a lower rate or to access equity for other compliant purposes is permitted, provided the loan remains limited to the original asset and the holding trust structure is maintained. Where a member transitions to pension phase and the fund's cash flow changes due to pension payments, reviewing your SMSF loan to confirm ongoing serviceability is a practical step.

Rental Income Treatment Across Accumulation and Pension

Rental income from SMSF property is treated the same way as capital gains for ECPI purposes. Where the fund is fully in pension phase and fully segregated, rental income is exempt from tax. Where the fund uses the proportionate method, the rental income is partially exempt according to the actuarial percentage.

This treatment applies whether the property is commercial or residential (for residential properties acquired under LRBAs established before 10 August 2026). The loan interest paid by the SMSF is a deductible expense in calculating the fund's taxable income, but only the taxable portion of income is offset by the deduction.

In a scenario where a Central Coast SMSF holds a small industrial unit in Wyong leased to an unrelated party, generating rental income while the member draws a pension, the tax treatment depends on whether the entire fund is in pension phase. If the member has fully transitioned and the fund holds no accumulation balances, the rental income is entirely tax-free. If the member retains an accumulation balance, the fund must obtain an actuarial certificate and only part of the rental income is exempt.

What Happens If You Breach Pension Minimum Payments

The outcome depends on the ECPI method used, whether an actuarial certificate is required, whether minimum pension payment requirements have been satisfied, and the fund's specific circumstances. If a pension fails to meet the minimum payment requirement in a financial year, it may cease to be a retirement phase income stream for that year. The fund would lose the ECPI exemption for that pension for that year, and income and gains would be taxed in accumulation phase.

This does not directly affect the LRBA or the property loan, but it does affect how rental income and any capital gain on sale are taxed. If the pension stops being a retirement phase income stream partway through the year and the property is sold in that year, the capital gain may be fully or partially taxable depending on the period the pension was in force and whether the fund can still use the proportionate method.

For funds holding property under an LRBA, maintaining pension compliance is relevant not only for accessing tax concessions but also for ensuring the fund's cash flow remains adequate to service the loan after making pension payments.

Moving a Property Out of Pension Phase

A property held under an LRBA cannot be directly allocated to a specific member account or designated exclusively to pension or accumulation. The holding trust and loan structure apply at the fund level. However, where a member commutes part or all of their pension back to accumulation, the fund's proportion of pension-supported assets changes, and this affects the tax treatment of income and gains going forward.

If a member fully commutes a pension, the fund may move from a fully segregated position to a mixed position, requiring an actuarial certificate for future income years. If the property is sold after that change, the capital gain would be only partially exempt unless the member re-enters pension phase and the fund regains full segregation for the entire income year in which the sale occurs.

Where a couple holds property in their joint SMSF and one member transitions to pension phase while the other remains in accumulation, the fund must use the proportionate method. The property's income and any capital gain are split between exempt and taxable portions based on the pension-to-total ratio, even if one member's contributions funded the entire deposit.

Call one of our team or book an appointment at a time that works for you. We work with Central Coast SMSF trustees and their advisers to structure SMSF loans that support both accumulation and pension phase goals, and we can help you assess refinancing options or borrowing capacity as your fund's position changes.

Frequently Asked Questions