Yes, you can build a granny flat on your SMSF investment property, even if it is under an LRBA, provided it does not alter the fundamental character of the asset.

Under an LRBA, the acquired investment property must remain essentially the same throughout the loan term. Significant modifications, such as major renovations, structural alterations, or developments, are generally not allowed. This means you cannot:

• Completely remodel the kitchen or bathroom.
• Add new rooms or significantly alter the existing structure.
• Subdivide the land or undertake a knockdown rebuild.

However, according to SMSFR 2012/1, constructing a granny flat on the same land as the SMSF investment property is permitted. For example, if you purchase a property with an existing four-bedroom house and later build a granny flat in the backyard with two bedrooms, a family room, a kitchen, and a bathroom, this does not breach LRBA rules. Since the granny flat is an extension of the residential premises rather than a transformation of the asset, the property remains fundamentally the same.

On the other hand, building a granny flat on vacant land under an LRBA is not allowed, as it would breach the Single Acquirable Asset rule. Under this rule, the asset acquired under an LRBA must be a single, identifiable asset at the time of purchase. Developing a vacant block into a residential property with a granny flat would change its nature, making it a different asset from what was originally acquired, which is not permitted.

Building a granny flat can be a smart income and capital growth strategy for your SMSF, provided you have the additional funds for construction. Since granny flat construction is allowed under LRBA rules, owning an SMSF investment property with a large block of land could provide a dual income stream, enhancing your fund’s cash flow and long-term growth potential.

However, before proceeding, it’s crucial to consult with a financial planner or tax expert to fully understand the tax and compliance implications of this strategy. If you need further information or clarification, feel free to contact Investax—our SMSF specialists are here to help!

Reference – SMSFR 2012/1