Can You Use Investment Equity to Fund Your SMSF Property?

We had recently helped a client establish her Self-Managed Super Fund (SMSF) — an exciting new chapter in her investment journey.

Over time, she had accumulated strong equity in her two investment properties and maintained substantial savings in the offset accounts attached to those loans. The offset structure worked beautifully: every dollar in the offset reduced the daily interest charged on her investment loans without affecting the loan principal — a flexible and tax-effective strategy many investors wisely use.

But then came her next idea.

She wanted to refinance the two properties, cash out more equity, and combine that new cash with her existing offset balances. The plan was to use those combined funds to pay the deposit on a property to be purchased by her newly established SMSF.

Her reasoning was straightforward — if the SMSF borrowed less, the total interest (at SMSF’s typically higher rates) would be lower. A financially smart idea, at least on the surface. However, under closer analysis, the arrangement breaches multiple areas of tax and superannuation law.

Offset Accounts and Loan Purpose – Income Tax Law

The offset account reduces the interest cost on a linked loan but does not change the purpose of the underlying borrowing.

When funds are withdrawn from an offset and redirected for a new purpose, such as contributing to an SMSF or paying an SMSF deposit, that portion takes on a new purpose for tax deductibility purposes.

Under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997), interest expenses are deductible only if incurred in producing assessable income or carrying on a business for that purpose. The borrowed (or redrawn) funds used for SMSF contributions do not produce assessable income in the member’s hands — they represent personal capital movements. Therefore, the interest on that portion is not deductible.

This position aligns with Taxation Ruling TR 2000/2, which confirms that the use of borrowed funds — not the security — determines deductibility. Similarly, ATO ID 2002/100 reinforces that redrawn funds used for private or non-income producing purposes lose deductibility, even if secured by an income-producing asset.

Refinance and Cash-Out Equity – Superannuation Law

The next legal issue lies under the Superannuation Industry (Supervision) Act 1993 (SIS Act).

By refinancing and using borrowed funds to assist her SMSF in acquiring property, the client’s plan risks breaching:

• Section 65 – Financial assistance to members or relatives

  An SMSF cannot provide or receive financial assistance using a member’s resources or credit. Even indirect assistance — such as a member using borrowed money to “help” the fund pay a deposit — contravenes this section.

  
  

• Section 67 – Borrowing restrictions

  An SMSF must not borrow money except under a Limited Recourse Borrowing Arrangement (LRBA) that meets strict requirements under section 67A and 67B. The member’s refinance funds, even if transferred to the SMSF, are considered external borrowings and therefore non-compliant.

  
  

• Section 62 – The Sole Purpose Test

  Every SMSF transaction must be for the sole purpose of providing retirement benefits. If borrowed personal funds are injected to “help” the fund or improve its short-term position, the ATO may see this as breaching the test.

  
  

Nature of Contributions – Source and Tracing

Under Regulation 7.04 of the SIS Regulations 1994, contributions to a super fund must be paid in money or in-specie, and the source of funds must be the member’s own money, not borrowed capital.

If the member draws funds from a personal refinance, the contribution becomes tainted, as it is indirectly financed through debt.

Further, ATO SMSFR 2009/2 clarifies that any arrangement where a member provides money, assets, or financial support to the fund (even indirectly) can amount to financial assistance under s.65.

This would make both the trustee and member potentially liable for civil penalties under section 166 of the SIS Act, and the fund could be rendered non-complying under section 40.

LRBA Limitations – Keeping Borrowings Inside the Fund

If the SMSF intends to borrow to acquire property, it must do so via an LRBA that meets the conditions under sections 67A–67B of the SIS Act.

That means:

• The loan must be made to the fund, not to the member.

• The borrowed funds must be used solely to acquire a single acquirable asset.

• The lender’s recourse must be limited to that asset.

  
  

The member’s personal refinance fails all these tests — the money was borrowed outside the fund, mixed with personal funds, and later used to assist the fund. Even if indirectly, this arrangement circumvents the LRBA rules and therefore breaches the borrowing prohibitions.

Consequences of Non-Compliance

A breach of these provisions exposes the fund and trustee to serious risks:

• Civil penalties up to 200 penalty units per trustee (currently $313 per unit as of 2025).

• The fund could be made non-complying, resulting in up to 45% tax on its assets.

• The trustee may be disqualified under section 126A.

• The interest portion on the refinance used for SMSF purposes becomes non-deductible under income tax law.

  
  

A Compliant Path Forward

To achieve similar objectives within the law:

Objective	Proper Method	Legal Basis
Inject funds into SMSF	Make personal contributions within concessional or non-concessional caps	SIS Reg 7.04, ITAA 1997 s290-60
Reduce SMSF borrowing	Use member contributions (not borrowed funds) to increase deposit	SIS Act s62
Borrow within SMSF	Establish a Limited Recourse Borrowing Arrangement (LRBA)	SIS Act ss67A–67B
Maintain offset flexibility	Keep offset linked only to investment loans, not SMSF-related transactions	TR 2000/2

What if the Member Does It Quietly?

Some trustees believe that if they quietly use personal refinance money to assist the SMSF — without telling anyone — it might go unnoticed. However, in superannuation law, a breach exists the moment the action occurs, not when it’s discovered.

Every SMSF is subject to annual independent audit under SIS Reg 8.02B, and the auditor must trace all deposits and contributions. If a transfer appears to originate from a personal or offset account linked to a property loan, it will likely be flagged and reported in an Auditor Contravention Report (ACR) to the ATO under section 129 of the SIS Act.

Even if an adviser is unaware, the ATO’s data-matching systems — integrating SuperStream, banking, and property transaction data — can detect irregular fund movements.

If detected, the trustee (not the adviser) bears full liability. As with all compliance matters, the intent to “help” does not erase the breach. In superannuation law, structure and traceability determine legality, not motive.

Final Thought

The line between a clever structure and a compliance breach is often invisible to the untrained eye. Our client’s intention — to strengthen her SMSF position — was genuine and financially rational. Yet the execution blurred the boundaries between personal and superannuation finance.

In the eyes of the law, intention doesn’t override structure. And in the world of superannuation, structure is everything.

Offset accounts remain one of the most efficient tools for investors — but once borrowed money crosses into the superannuation space, the SIS Act takes precedence over financial logic. Every dollar entering the fund must be traceable, unborrowed, and independent. In the end, sustainable wealth is built not just through smart strategy, but through careful adherence to the rules that govern it.