Many investors are attracted to self-invested personal pension schemes (Sipps) as they give them an element of control over their investment strategy. There are a range of reasons why people wish to invest their pension funds directly into commercial property.
One of the main reasons is the tax advantages. Firstly, by making contributions into a pension fund either the individual or his or her company will receive tax relief. Therefore, by routing money into pension schemes via contributions prior to acquiring the property in the scheme, the purchase price is effectively being subsidised by the tax relief paid into the fund by Her Majesty's Revenue and Customs (HMRC).
Similarly, paying rent into a pension scheme is treated as a business expense and can be offset against taxable profits in the client’s business, and once paid into the pension fund, the rent can be reinvested to grow tax free in the fund. As pension schemes do not pay capital gains tax, any increase in value would not be taxed following sale of the property either.
Buying a commercial property in a pension and having the ability to effectively pay themselves rent (via the pension scheme) in a tax efficient manner has far more appeal than paying a third party landlord, who may not take as much care of the premises as an owner occupier.
Over recent years, many people have elected to register their pension schemes for protection from the HMRC lifetime allowance charge, on the basis they anticipate accruing pension funds in the future higher than the current lifetime allowance of £1.25 million. This requires them to cease making pension contributions, however where they have invested directly into commercial property and their business occupies the property, their company can still get the tax benefits of paying the rent into the fund, as the rental is not restricted in the way contributions are.
Often, the business premises are held in the company and moving the property into a pension scheme can help manage trading risk for an entrepreneur. If the company got into financial difficulty the asset would be held separately and would not be accessible to creditors.
Where the premises are owned by the company, or the company directors personally, using pension funds to buy the property can also be a way of releasing cash back to the individual or the company as the money would be paid from the pension scheme as cash in exchange for the property. The cash can then be used for working capital in the business, or even used to fund pension contributions back into the scheme, attracting further tax relief.
Pension schemes are also able to borrow to help fund the acquisition of commercial property. HMRC permits borrowing up to 50% of the net asset value of the pension scheme. Joint purchases are also possible, either in conjunction with the individual personally or their company. It is also possible for groups of individuals to use their pension schemes to jointly acquire a property to increase scale and affordability, making it possible to acquire larger, more expensive property than would be possible on an individual basis.
Besides the various advantages, there are also possible downsides which need to be borne in mind. Property is an illiquid asset and it can take time to sell. Similarly, the cost of stamp duty land tax needs to be factored in when purchasing commercial property, and where VAT is being charged, the possibility of stamp duty also being payable on the VAT portion: essentially tax being charged on a tax. Professional fees such as legal costs and surveyors fees also need to be considered.
Where the premises are owned by the company or the directors personally, care must be taken to factor in any capital gains tax that would be payable on the disposal, to determine the overall benefit of selling to the pension scheme.
Over the course of ownership investors are likely to also have to pay maintenance costs, legal fees for drafting leases, and agents fees for marketing the property and finding new tenants.
Since the financial crisis started in 2008, many landlords have had to offer incentives to attract tenants into their properties, including extended rent free periods, restricting income streams into the pension fund and creating challenges for pension Trustees who have to meet loan repayments.
In situations where there is no tenant, empty business rates can become payable and if there is no other income available in the pension to cover these rates there may be a requirement for the individual to make additional pension contributions. Again, this risk is compounded where borrowing has been used to acquire the property, as the mortgage repayments will need to be paid irrespective of whether there is a tenant in situ or not.
Overall, owning a commercial property in a pension scheme offers a range of tax advantages and can offer the ability for entrepreneurs to align their pension investment strategy with their wider business ambitions, however, as with any investment, the downsides need to be considered.
About the author
Scott Harrison is Pensions Director at Prydis
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