How to invest in commercial property through a SIPP

Direct investment in commercial property through a SIPP is becoming increasingly popular despite the downturn, says Oliver Crichton.

Commercial property is fit for SIPP ­acquisition and this ­typically means ­offices, shops, ­industrial units and ­farmland. Unusual ­properties such as zoos and parking spaces can also be accommodated.

Essentially, commercial ­property means all property that is neither residential nor a tangible moveable asset (TMA). Punitive tax charges would be incurred by both the SIPP and the investor if residential or TMA properties were acquired.

Residential property is defined as a ­building or structure that is used, or is ­suitable for use, as a dwelling and includes related land used as a ­garden or grounds in connection with the building.

But there are certain types of property excluded from this, even though they fall within the above definition. These include care homes, hospitals, prisons and ­hotels. If a residential property is used in connection with a business space held as an investment by the SIPP, as well as being occupied by someone unconnected to the investor, then it can also be acceptable.

Why invest through a SIPP?

Generally, tax is the biggest ­reason to use a SIPP to purchase and hold commercial property. There is tax relief on both personal and ­employer contributions. The tax ­relief on personal contributions means that subject to contribution limits, the pension fund will reclaim 20% on such contributions with higher-rate tax payers claiming the balance through self-assessment.

Once acquired, there is no tax on rental income received by the SIPP. This means that borrowing taken out to help the purchase can ­generally be repaid more quickly than would be the case outside of a SIPP. In addition, any gains made on sale will be ­exempt from capital gains tax. In the ­ordinary course of events the SIPP’s assets, ­including the property, should fall outside the investor’s estate for inheritance tax purposes.

But from 6 April, where lump sums are paid out on death, the tax charge will be 55% if benefits are in payment or if the investor is over 75.

Also, for about half of all SIPP property cases, the tenant of the property will be the investor’s ­business, which must pay a market rent to the SIPP. The rent paid to the SIPP should be a tax-deductible business expense so that it can reduce the income/corporation tax liability of the tenant.

The rules of the game

Since April 2006, the rules have permitted business owners to sell their premises to their SIPP at market value, meaning an injection of cash for the business in return for selling the property to the SIPP. This has enabled businesses to access cash within the pension fund during a time when many businesses have found themselves short of cash. The sale to the SIPP must take place at market value as advised by a qualified valuer.

Falls in property prices have enabled SIPP investors to acquire property investments which would have previously been beyond their SIPP’s means. Historically, investing in property has been seen as a good hedge against inflation and with a sound tenant in situ decent returns can be expected.

A word of wording, though: increasing numbers of tenants have fallen into financial difficulties – even insolvency – resulting in rental income drying up. Loan ­repayments and other expenses such as ­business rates, service charges and SIPP provider fees will still need to be met by the SIPP, even if the property is empty.

How does a SIPP acquisition go through?

To proceed with the ­acquisition, the SIPP will need ­sufficient funds. This may be achieved through ­contributions (personal or ­employer) or transfers in from other pension schemes. In addition, the SIPP is permitted to borrow up to 50% of the SIPP’s net fund value.

Groups of SIPP investors can combine their pension funds in order to fund the purchase. It is common for groups of professionals to purchase their business premises using this method. With the right SIPP provider, a part-share in the property can be acquired by the SIPP with the balance being owned outside the SIPP.

Fees and disbursements are ­inevitable where a property ­transaction is concerned and this includes transactions between the SIPP and a ‘connected party’. There will be valuers’ and ­solicitors’ fees to consider, as well as an arrangement fee if the SIPP is to borrow. Disbursements, including stamp duty land tax, will be payable and the sale to the SIPP will be a chargeable event for the purposes of capital gains tax on the settlor.

Oliver Crichton is director of property at Suffolk Life