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Adviser  >  Technical Central  >  Support material  >  Case Studies  >  Buy to let case study

Buy to let case study

One attractive feature of UK pensions is that they are allowed to invest in commercial property and benefit from various tax breaks that would not otherwise be available. For example, the property can be leased with the rent being paid directly into the pension scheme – tax-free. Whilst commercial property investment has long been available to UK pension schemes, Pensions Simplification has removed a major restriction from 6 April 2006 (A-Day) - people can now use their pension scheme to purchase a property that they or an ‘associate’ (e.g. spouse, close relative) own. There are certain conditions which must be met however. In particular, if the property is rented by a member of the pension scheme or an associate of the member on a non-commercial basis, it will be treated as a benefit-in-kind and a tax charge will apply. 40% of the difference between the commercial rate and the rate actually paid by the member or associate will be chargeable to the pension scheme member and there may also be other tax charges levied on the pension scheme itself.

It is possible for the scheme Trustees to borrow money to assist in the purchase of a property. The amount that can be borrowed is limited to 50% of the current value of the scheme, less any outstanding loans. 100% of scheme assets plus any scheme borrowings can be used to purchase a property and pay for the associated costs e.g. legal fees.

Example

Gemma runs a successful sandwich shop on her local high street. She bought the shop 10 years ago using money that was left to her when a family member died. Since Gemma started to run her own company she has been paying what she thought was the maximum contribution into a personal pension plan.

Before she became self-employed she worked for a large company that had a good contracted-in money purchase pension scheme (CIMP). She currently has a paid-up benefit of £82,000 in that scheme.

Gemma has heard that there can be tax advantages in having a property as an asset of a pension scheme and thinks that it might be a good idea to sell her shop to her pension scheme. She speaks to her financial adviser who explains that under the new pension rules it is possible for her to sell her shop to her pension scheme. He advises her that a market value must be paid by the pension scheme when it buys the property from her and that the company must also pay a market rate of rent to the pension scheme, otherwise tax charges will apply. It is also possible for Gemma to increase her gross pension contributions as the amount that she can pay towards her pensions (and receive tax relief) increased to 100% of earnings from A-Day.

After speaking to her adviser Gemma is interested in using the money from her paid-up CIMP to buy the sandwich shop, valued at £110,000. She would like to keep the money in her personal pension plan separate to spread her overall investment risk.

Gemma sets up a self-invested personal pension plan (SIPP) and transfers the money from the CIMP into it. She also starts to pay £7,500 per annum into the SIPP on top of the premiums that she’s already paying into her personal pension. She speaks to her adviser who confirms that her SIPP is worth £85,000 and that an additional £42,500 could be borrowed by the pension scheme bringing the total amount available to purchase the shop to £127,500. Gemma has to remember that her pension plan may have to cover all the costs involved in the purchase of the shop e.g. legal fees and survey costs. The IFA arranges for Gemma’s SIPP to buy the shop using a combination of existing money and borrowings, with the remainder of the SIPP invested in insured funds.

Once purchased:

• the rent is paid by Gemma's business straight into Gemma’s SIPP, with no tax due
• the loan used to buy the property will be paid for by the SIPP using the funds built up via rent which will have been paid into the SIPP tax-free or by contributions that will have received tax relief
• any maintenance or upgrading costs, factor fees and any bills will be paid for by the SIPP and not by Gemma personally. Again, these will be paid for using the SIPP funds built up via rent paid into the SIPP tax free or by contributions that will have received tax relief
• not all of her money is invested in the property, spreading her investment risk
• if Gemma decides to take her benefits using unsecured pension or alternatively secured pension at retirement, and does not sell the property, it may not be possible to take as much as 25% tax-free cash as there may not be enough ‘liquid’ assets. Care will also have to be taken that there
  are enough 'liquid' assets to pay an income to Gemma
• if the property is sold by the SIPP in the future there will be no Capital Gains Tax to pay.
  

Buying property this way can be very tax efficient. This is highlighted below in a comparison between a person using their pension scheme and an individual buying a property themselves:

Property purchased though a pension scheme	Property purchased by individual
The pension scheme owns the property and not the individual	The individual owns the property
The SIPP can borrow up to 50% of the value of the pension fund to assist in the purchase of the property	Unless the individual has free capital, they may need to borrow up to 100% of the value of the property
The loan and any interest will be repaid by the pension scheme from tax-advantaged funds	The individual will pay the mortgage from income that has probably been taxed
Rent will be paid straight into the pension scheme tax-free	The rent will be paid to the individual but it will be taxed at up to 40%
Legal fees, stamp duty (if applicable), survey costs, maintenance, bills, insurance, Trustees fees and any upgrades will be paid by the pension scheme	Legal fees, stamp duty (if applicable), survey costs, maintenance, bills, insurance and any upgrades will be paid by the individual
When the property is sold there will be no Capital Gains Tax due	When the property is sold Capital Gains Tax of up to 40% will need to be paid
When the member takes their retirement benefits 25% can normally be paid tax-free, the rest will be paid as an annuity or unsecured pension	Once any Capital Gains Tax is paid the individual is free to use the money any way they please
If the member dies the property may not form part of the member's estate for Inheritance Tax purposes (with the exception of alternatively secured pension where Inheritance Tax may apply)	If the individual dies the property will form part of the member's estate for Inheritance Tax purposes which could mean a tax charge of up to 40% of the value of the property

References to taxation are based on our understanding of the current law and practice and may be affected by changes in legislation or by an individual’s particular circumstances.

This case study is an example only, and whilst it highlights some of the opportunities for planning, it should be recognised that it is not a complete or exhaustive description of the opportunities or pitfalls. This information is based on our current understanding of the Finance Act 2004, Finance Act 2005 and other relevant legislation.

Published April 2006

Updated 30 May 2008