Should you put your practice property in a pension?
This article by Jon Drysdale, an independent financial adviser for Chartered Financial Planners PFM Dental, was first posted on www.smile-onnews.com
For many years it has been possible to place your practice freehold (the bricks and mortar element of the business) into a pension. However, there are some significant barriers to entry which are often misunderstood. Tighter rules on annual pension contributions and a reduced Lifetime Pension Allowance can make the exercise even harder to justify. So, let’s consider whether placing your practice property in a pension is a viable option.
Which pensions accept property?
Your practice property won’t go into any of the following: a personal pension, a stakeholder pension, an NHS or workplace pension. Most pension contracts won’t accept a commercial property as an allowable investment. The reason is simple – placing bespoke assets, such as property, into a pension is uncommon and is not profitable business, except for a few pension providers with specialist property departments. SIPPs (Self Invested Personal Pension) and SASS (Small Self-Administered Schemes) can accommodate commercial properties.
Why would you put your property into a pension? As with other pension assets, growth within a pension tends to be tax-free. Sheltering your property within a pension means that growth year-to-year doesn’t suffer any tax liability. When eventually sold, the property won’t be subject to capital gains tax. Furthermore, rental income will build up in the pension (more on this later). Unfortunately, if this sounds too good to be true then it is, for a number of reasons: First, when you eventually sell the property the cash proceeds and accumulated rent monies will remain in your pension. You will be subject to the usual pension rules such as income tax on withdrawals, potential Lifetime Allowance charges etc. Second, placing the property in your pension is likely to be a ‘disposal’ and therefore trigger capital gains tax (CGT), probably at 20%. For example, you place a property worth £250,000 in your pension having purchased it for £100,000. The gain charged at 20% is £150,000 less an £11,100 CGT allowance, less acquisition and disposal costs. Third, in this example a charge of £2,500 would be applied in respect of Stamp Duty Land Tax (SDLT) when the pension purchases the property.
How to go about it
There are various ways to place a property in a pension. These are primarily:
1. An In-specie transfer
2. A new pension contribution
3. Your existing pension funds purchase the property
HMRC has recently challenged the In-specie transfer route and most providers no longer offer this as an option. Transferring the property to your pension as a new contribution may bring you into conflict with HMRC pension contribution limits. This restricts you to a £40,000 annual allowance. You may be able to use ‘Carry Forward’ relief to mop up previous years’ unused annual allowances, however, this will be limited if, for example, you have ongoing NHS pension contributions. The maximum contribution would be £180,000 assuming you have made no pension contributions in the current or three previous tax years. Whether or not this contribution is eligible for tax relief will depend on your income tax position. In any event, many properties have a value in excess of £180,000 – so you may need to absorb the property into the pension over a number of years.
The third way
Using your existing funds alone or in conjunction with option 2 may be a viable route. In practice, this works as follows: your personal pension funds can be transferred to a SIPP in the form of a cash transfer. The cash is then used by the SIPP to purchase the property. Care needs to be taken with this transaction to ensure transfer penalties are not invoked and that the market conditions are favourable when selling funds to generate cash. If your existing funds are not sufficient to purchase the property then making an additional contribution by way of a top-up may be an option, subject to the usual contribution rules.
There are a few other considerations in what can be a complex area of financial planning. SIPP providers vary and not all will accommodate commercial property. Not all commercial properties are eligible, for example, a property with a residential component, environmental issues or restrictive conditions of ownership may be problematic. In any event, the SIPP provider will need to confirm property eligibility.
Costs tend to be greater than with a personal pension. Property administration fees of £500pa are common with initial set-up costs likely to be in the region of 1-2% of the transaction value. Last, it is worth bearing in mind that the property will be owned by the SIPP trustees on your behalf. This means that a market rent will need to be paid into the SIPP, something which you may not be accustomed to. If you want to develop the property in any way you will need to seek the ongoing approval of the trustees and meet fairly stringent development conditions and project management standards etc.
Cost and contribution restrictions can be shared and SIPPs can usually accommodate part ownership of a property. So if you jointly own a property your share only could be held in the SIPP.
A substantial amount of rental income could build up depending on the length of time the property is held within the SIPP. There is no income tax liability on this income so it is an effective way of increasing the overall size of your pension assets. Advice will be required to implement and review an appropriate investment strategy as holding funds in cash is a poor long-term prospect, especially in this low interest rate climate.
Incorporating your pension into a SIPP offers long-term tax efficiency and the opportunity to swell retirement income. The barriers to entry are a significant factor, consisting mainly of restrictions on contributions and initial costs. Careful planning and expert advice is essential with this type of transaction.