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How to buy commercial property using a SIPP

Harness the power of pensions

As a pensions actuary, I’m well aware pensions don’t have the sexiest reputation. In fact, most people would rather talk about your recycling habits than pensions. However, I’m a strong advocate for financial responsibility and retirement planning. So, I feel duty-bound to spread the word about pensions and highlight the benefits they have to offer. So, I’d like to talk about how you can using a SIPP to invest in commercial property and other investments. This could be as a supplement to other property investment activities or in place of them. I can’t promise to make pensions any sexier. However, I can promise that by the end of this post, you’ll have a much better idea of where to start and how to go about it, if you want to harness the power of pensions to help you meet your property goals.

Why use a SIPP to invest in commercial property?

A pension is a fund you pay money into while you’re working and take money out of after you retire. There are lots of different types of pension, including state pensions, company pension schemes, and personal pension plans. Here, we’re just going to discuss one type of personal pension available in the UK known as a self-invested personal pension (or SIPP). You can use a SIPP to invest in property. But before we get into all that, let’s look at why you might consider using a pension to save for your retirement.

1. Tax relief on contributions

You can get tax relief on pension contributions up to 100% of your annual earnings. Depending on the type of pension plan and whether you’re a higher rate taxpayer, you may need to claim some or all of this back via your self-assessment tax return at the end of the year.

2. Tax-free investment returns

While your savings remain in the pension plan, any investment returns earned by the fund are not subject to tax.

3. Tax-free cash lump sum

When you retire, you can withdraw up to 25% of the fund as a tax-free cash lump sum. You can use the rest of the fund to provide an income, which you’ll then pay income tax on.

How to use a SIPP to invest in commercial property

A self-invested personal pension (or SIPP) is a government-approved personal pension scheme available in the UK. It’s a ‘tax wrapper’ that has all the same tax advantages we discussed above. That is, it allows tax rebates on contributions. However, it allows for a much greater choice of investments than other personal or company (occupational) pension schemes. As such, you can use a SIPP to invest in property / commercial property to a greater extent than with other types of pension plan.

How are SIPPs structured?

From a structuring perspective, SIPPS are single-member personal pension plans. They are usually set up under a master trust framework. That is, there is one legal trust and one trustee board that governs the plan. This helps keep operating costs lower, but it allows the plan to retain a strong governance framework. The SIPP provider normally acts as the trustee and has certain responsibilities. Some SIPP providers also appoint the member (that’s you) as a joint trustee, but this is less common. The provider has overall control and is in charge of the day-to-day operations. The investments are registered in the name of the trustee, and the provider decides which investments are allowable. However, it’s the member (you) who makes the investment decisions. As such, a SIPP is a product for sophisticated investors who know what they’re doing and want full control of their investments.

What kinds of investments are available?

A SIPP has a much wider range of investment powers than other types of personal pension. In general, the SIPPs that allow their members to hold specialist investments like property will have higher charges. So, you will pay for this greater flexibility. SIPPs can also borrow money to purchase investments. For example, you could raise a mortgage to part-fund a property purchase through your SIPP. So, it is possible to use some leverage, but there are limits around how much you can borrow. The general rule of thumb is you can borrow up to 50% of the value of your SIPP to finance a commercial property investment. In general, you can use a SIPP to invest in the following types of assets.

Stocks and shares

You can buy stocks and shares, as long as these are listed on a recognised stock exchange.

Government and corporate bonds

Government bonds (e.g. UK government gilts) are loans made to the government. Corporate bonds are loans made to companies. They usually pay interest and a return of the borrowed monies.

Investment funds

You can invest in a wide range of collective investments, including property funds and real estate investment trusts (REITs).

Commercial property

SIPPs can invest in all the usual types of commercial property, including retail, office and industrial buildings. They can also be used to invest directly in commercial property, not just through commercial property funds.

Land

You can invest in agricultural land, woodland, or land that has a commercial use, e.g. access roads, car parks, etc.

Gold bullion

SIPPS can invest in gold bullion, provided that the gold is ‘investment grade’.

Derivatives

You can also use a SIPP to invest in derivatives like futures and options that are traded on a recognised exchange.

So, the range of potential investments is vast. However, there are also some restrictions. For example, there are investments that are permitted by the primary legislation, but which were subsequently made subject to heavy tax penalties. This includes ‘exotic’ assets like vintage cars, wine, stamps and fine art. It also includes residential property, unfortunately. In practice, therefore, most SIPP providers don’t allow you to hold any residential property. This includes buy-to-lets, HMOs, and residential ground rents. From a property investment perspective, that means you’ll mainly be able to use your SIPP to invest in direct commercial property investments. You can also take a stake in any property funds permitted by your SIPP provider.

What fees will I pay?

Each SIPP provider will have their own fees. The charges can be extensive, so you need to check these out carefully before you pick a provider. SIPPs come in a variety of shapes and sizes with vary pricing structures and fees. However, I would divide them into two main camps.

1. Low-cost SIPPs

Most investors prefer these, but the investment options are limited. They give you access to anything that can be easily traded on an online platform. At the simplest end, these SIPPs are limited to investment options like unit trusts and other pooled investments. If you want to hold complex assets, e.g. commercial property, you’ll need to look elsewhere. Fees include an annual fee, set as a fixed fee or a percentage of your portfolio. There will also be dealing fees for buying and selling stocks or funds.

2. Full SIPPs

These SIPPs offer the widest range of investment choices. They allow you to invest in commercial property and trade stocks and options on a stock exchanges. They also allow you to invest in gold bullion and take stakes in hedge funds. The priciest SIPPs even allow trading in risky commodities. Fees for these SIPPs typically include a set-up fee of several hundred pounds. They will have an annual fee set as a fixed fee or a percentage of your portfolio, which can run to hundreds of pounds per year. If you invest in commercial property, there will be all kinds of extra set-up costs and fees for annual management.

When it comes time to take your pension, there can be extra costs and charges like drawdown fees or exit-transfer fees. For example, there can be charges for transferring funds into or out of your SIPP. This is an area you’ll want to try to understand upfront, before you go down the SIPP route. It’s also an area where an Independent Financial Adviser (or IFA) can add a lot of value. An IFA can help you get this set up the right way and make sure you’re running things efficiently from a tax and fees perspective.

Keys to success when using a SIPP to invest in commercial property

You now have a better feel for the different types of SIPP and how they work. So, let’s look at some of the keys to success, if you use a wan to use a SIPP to invest in commercial property.

Pick the right type of SIPP

The range of SIPPs on offer can be overwhelming. So, it helps to narrow down your choices if you know what you want it for. If you simply want to invest in property funds and REITs, a low-cost SIPP will do the trick. If you want to invest directly in commercial property, you’ll need a full SIPP that allows this option.

Take advice from an IFA

If you’re thinking of setting up a SIPP, make sure you take advice from an IFA to ensure you set this up in the right way. This is particularly important if you’re thinking of transferring an existing pension pot into a SIPP product, as pension transfers can be complex. You need to fully understand all the impacts here. A good adviser will be there to support you in your decision making and help to make the right choices.

Work with a reputable provider

Although SIPPs are portable, you want to be working with a reputable provider from the start. Some providers will be new to the market, others will have been providing this service for years. You should research the different providers, understand their strengths, and make sure that the SIPP they provide can do what you want it to do. Again, an IFA should be able to help here.

Understand the fees and charges

Understanding the fees and charges is important. You should make sure you read and understand the provider’s terms and conditions and that you are fully up-to-speed on the costs. If you don’t understand how a particular fee or charge works, speak to your IFA or to the provider and ask them to explain it. This is particularly the case when you’re investing in commercial property using a SIPP. Here, there will be fees on purchase and sale, taking out a mortgage, and administration fees. There will also be fees for ongoing management, such as VAT returns, mortgage fees, rent reviews, etc.

Understand the governance

You’ll want to understand how decision making and governance works for your SIPP. For example, can you liaise with the provider directly, or will you need to do this through an IFA?

Think about your exit strategy

You need to check the SIPP will allow you to draw your pension in the way you want. For example, some providers allow flexible drawdown (drawing a pension in instalments) and some don’t. Make sure you’ll be able to access your funds in the way you want when it comes to retirement.

Finally, I want to stress again that if you’re thinking about transferring an existing pension pot into your SIPP, you should take independent financial advice from a qualified IFA. This is even more important if you’re thinking about taking a transfer from a defined benefit (“DB”) pension plan. That’s the technical name for older types of UK pension plan that often provide pension benefits linked to your salary and years of service for a company. These DB pension benefits can be very valuable, and the decision to take a transfer can be complex. Again, an IFA will be able to help you understand the financial impacts of taking a transfer from a DB scheme.

Reversal

If you only have a small pension pot, you’re unlikely to find it cost effective to use a SIPP. With the cost of opening and running a SIPP potentially running to hundreds of pounds each year, it’s not going to be worth it, if you’ve only got a few thousand pounds to invest. If you’re in this category, a more cost effective and still somewhat tax efficient strategy might be to invest via a stocks and shares ISA, where any investment returns earned will still be exempt from tax and you won’t pay tax when you withdraw funds. With an ISA, you’ll be able to invest in property funds and REITS. However, you won’t be able to invest directly in commercial property.

For more on using a SIPP in invest in commercial property

That brings us to the end of this post on investing in property and commercial property with a SIPP. This post is based on a chapter from our book, The Property Investment Playbook – Volume 2, which is available on Amazon. If you enjoyed it, why not check out the book.

Until next time, best of luck with your future property endeavours.

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The property tax advice you need to succeed

Setting yourself up for success with the right property tax advice

Like it or not, the amount of tax you pay will affect your final investment profits. As such, getting set up with the right tax structure and getting the right property tax advice is important. Starting out with the wrong tax structure could cost you hundreds or thousands of pounds each year in lost returns. In this post, we’re going to look at the two main options most investors use to set up their property portfolio, what taxes you’ll pay under each, and how you can work out which structure is right for you. If at the end you’re still looking for more, speak to your property tax accountant.

It’s worth saying that tax is a big topic and one where things are constantly evolving. What we’ll cover here is just a starter, and it isn’t a replacement for getting the right property tax advice from a property tax accountant. Hopefully, it will give you a feel for what the right tax structure might be for you. Crucially, it will arm you with enough knowledge to seek out an property tax accountant that can help. The right tax structure will depend on your personal circumstances and on your goals. It’s something that needs careful consideration, so make sure you take the time to get it right.

What taxes will you pay?

Whatever your property strategy, be it buy-to-lets, serviced accommodation, or holiday lets, the two main options available for setting up your property rental business are as a sole trader or as a limited company. Let’s take a look at how these options work and what taxes you’ll pay.

The sole trader

If you set up your business as a sole trader, you’ll buy properties and let them out in your own name. The main taxes you pay will be as follows:

• Income tax – You’ll pay income tax on rental profits – that is, the profit you make after you deduct your running costs from your rental income.
• Capital gains tax – When you sell a property, you’ll be taxed on the gain you make, i.e. the increase in value after allowing for purchase costs.

You (or your estate) could also be liable to pay inheritance tax on the value of your portfolio when you die. However, that’s beyond the scope of this particular discussion.

The income and capital gains tax rates, as well as the different thresholds and allowances, change all the time. So, you should look up the latest rates on the gov.uk website. What you need to know is that the rate you pay depends on whether you’re a higher or a basic rate taxpayer. And, higher rate taxpayers pay more tax on income and capital gains. Also, there’s currently a capital gains tax (CGT) allowance you can offset against any gains that you make when you sell a property. This can help lower lower your tax bill. Again, full details are available on the gov.uk website.

The limited company

If you set your business up as a limited company, your company will buy and let out the properties. The main taxes you’ll pay will be as follows:

• Corporation tax – The company will pay corporation tax on rental profits and on any capital gain you make when you sell a property.
• Income tax – As the owner of the limited company, you’ll pay income tax on any dividends you receive from the company.

The corporation tax rate changes all the time. You can look up the latest rates on the gov.uk website. In recent years, corporation tax rates have been lower than the income tax rate for higher rate taxpayers. For basic rate taxpayers, they’ve been at a similar level. You should also know that there’s no CGT allowance for limited companies. So, companies are taxed on the full gain they make when they sell a property. This is another difference versus owning property in your own name.

When you take money out of a company, i.e. by paying yourself dividends, you pay income tax on those dividends. Again, higher rate taxpayers will pay more tax on dividend income than basic rate taxpayers. However, there is a dividend allowance which allows you to draw some dividends out from the company tax-free. Full details on this are once again available on the gov.uk website.

Stamp duty

When you buy a property, you’ll need to pay stamp duty on the market value of the property. This is true whether you buy the property as an individual or as a limited company. However, it’s worth pointing out that if you don’t already own any property and you buy a property in your own name, e.g. to use as your home, you’ll pay less stamp duty. This is because you’ll avoid the stamp duty surcharge property investors need to pay when they buy investment properties.

Which tax structure is right for you?

At this point, you might be wondering which of these structures is right for you. Although this is a complex decision, here’s a look at some of the main factors you should take into account:

1. The headline tax rate

You should be aiming to pay as little tax as (legally) possible. This means you should pick the structure with the lowest headline rate of tax. The corporation tax rate is currently at 19% versus 40% income tax rate for higher rate taxpayers. So, investing through a limited company will give higher rate taxpayers a lower headline rate. If you’re a basic rate taxpayer, the headline income tax rate is currently 20%, and the comparison is not so clear.

2. Mortgage interest relief

Recent changes to mortgage interest tax relief mean that if you buy property in your own name, you can no longer deduct mortgage interest from your rental income as a cost of doing business. Instead, you get to deduct 20% of your interest cost from your final tax bill. Under this new system, higher rate taxpayers will pay more tax, and some basic rate taxpayers will also be pushed into the 40% tax bracket. None of this applies to limited companies, where interest costs are still tax deductible. Interestingly, the changes don’t apply to short term holiday lets in your own name.

3. Potential for double taxation

If you buy property in your personal name, you only pay tax on your rental profits once. However, if you buy in a limited company, the company pays corporate tax on its profits. Then, you pay income tax on the dividends you take out, so there is a potential for double taxation. If you don’t need the income to live off, you can leave the money in the limited company and reinvest it. Also, any money you inject into the company via a director’s loan to get the company started or to fund property purchases can be taken out without paying tax on the withdrawal.

4. The cost of borrowing

Though interest rates have come down and the landscape is now more competitive, borrowing costs remain higher for limited companies. Right now, the interest rate on a 75% loan-to-value mortgage is around 3.0% to 4.0% p.a. for a limited company. This compares with a rate of 2.5% to 3.5% p.a. if you buy in your own name. This should give you a feel for the approximate difference in costs.

5. Administration costs

When you run a limited company, that comes with extra responsibilities. You’ll need to file a set of accounts each year with Companies House. These accounts will need to be prepared in accordance with UK GAAP. You’ll also need to file a CT600 corporation tax return with HMRC. As such, if you go down the limited company route, you’ll need to pay a property tax accountant to prepare these for you, so there are extra costs. This is definitely an area where you need the right property tax advice, so don’t scrimp on these costs.

Pulling it all together

Any clearer now? Here’s my take on it all. If you’re just starting out in property, if you’re a higher rate taxpayer, and if you plan to reinvest your profits to build a decent sized portfolio, then the limited company route might be right for you. You’ll pay a lower tax rate, and your mortgage interest costs will be fully deductible. Also, you won’t get taxed twice, as you’re leaving the money in the company. The higher running costs won’t be too onerous, if you’re planning to build a larger portfolio of say five to ten properties.

If you’re a basic rate taxpayer, if you only plan to buy one or two properties, and if you need the income to live off, you’ll likely be better off investing in your own name. Your tax rate will be similar under either route. However, the extra admin costs for a limited company will be quite high relative to the profit you’re making. The potential for double taxation also makes the company route less attractive. The fact that borrowing costs are currently cheaper in your own name makes this option more attractive too.

Your circumstances may be a bit more nuanced. If you’re a bit of a mix and match of the above, then it may be less clear cut. As always, you should seek some property tax advice from a property tax accountant, to see what’s best for you.

What if you already own properties?

Transferring properties to a limited company

If you already own properties in your own name, you should think about what to do with these. The same considerations will apply as per the above. However, the decision on whether to keep them in your name or transfer them to a limited company is less straightforward. This is because there are costs attached to the transfer. You need to weigh up how the tax saving on transferring properties compares with the upfront costs of the transfer.

It is possible to transfer properties to a limited company. To do this, you need to sell the properties to the company at their current market value. This means you could be liable to pay capital gains tax. In addition, the company will have to pay stamp duty when it buys the property from you. In short, that means there are extra costs when you transfer the properties. Therefore, you need to weigh up how big the costs could be versus the tax savings you’ll achieve via the transfer. This can be complicated, and it’s one to take advice on. Make sure you take property tax advice if you’re considering it.

Transferring all or part of a property to a spouse

If transferring properties to a limited company doesn’t sound cost effective, there may still be things you can do. For example, you could transfer the ownership of part or all of a property to your spouse. This could be a way to “equalise” your incomes. So, it can offer a tax saving if your spouse is a basic rate taxpayer. Again, you should take some property tax advice from a professional, if you think it might work for you.

Property tax advice books and other useful resources

If you’re looking for some specific property tax advice or for a more detailed discussion on what we’ve covered here, then make sure to speak to a property tax accountant. You might also like to check out the following resources:

• the Tax Cafe book “How to Save Property Tax 2021/22” by Carl Bayley – available at Amazon
• the Tax Cafe book “Using a Property Company to Save Tax 2020/21” by Carl Bayley – available at Amazon
• the Government website at gov.uk for the latest on tax rates and tax reliefs
• the tax sections of the Property Tribes and Property Hub chat forums

Finally, it’s worth pointing out that in this section we’ve mainly covered tax issues relating to property rental businesses. If your property strategy means you’ll also be flipping properties for a profit, you should think about what the right vehicle is for those projects. In general, you’ll need to separate your property rental activities and property flipping activities into two separate business, as they’re treated differently from a tax perspective. Again, if you’re in doubt as to the best structure, make sure you get some property tax advice from a property tax accountant on this.

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