Pros and cons of investing in property in a Sipp

As property is commonly held for a significant length of time, Mr Leggett says gains may be large. The yield on property tends to be higher than the dividends from funds and equities, he adds.

He continues that many business owners may benefit from buying their work premises through their pension, as this can make “significant amount of cash available to the business for investment”.

When it comes to tax any capital gain resulting from an increase in the value of the property is exempt from capital gains tax, says Martin Tilley, director of technical services for Dentons Pension Management.

Any rental income is exempt from income tax, he adds. If VAT applies to the purchase of a property, Mr Tilley says it is possible to register the Sipp and elect to tax in respect of the property and thus reclaim the tax on the purchase price and/or any landlord improvements.

“A well tenanted property can provide an attractive return well in excess of other fixed interest assets, with the potential for capital gain,” he says.

“A property held in a pension scheme is in a totally separate legal entity to the member and/or his company so it would be protected in the eventuality of financial distress of the member or the company.”

Where the investor is also the owner of the business renting the property from the Sipp, Barnett Waddingham’s Mr Leggett says there may also be benefits to the business as rent is an allowable business expense.

Owning a business property can also be useful for succession planning, says Rownamoor’s Robert Graves, where instead of purchasing via a number of individual Sipps a group Sipp or small self-administered scheme could be instead used to enable property ownership to remain unchanged.

Claire Trott, head of technical support of Talbot & Muir, adds the new death benefit rules will make investing in commercial property more popular for members even into their retirement, because it can be handed down the generations, tax free in some cases.

With the possibility of leaving the pension and the asset to a non dependent beneficiary as a pension fund, rather than paying it out as a lump sum, Ms Trott there is much greater scope to avoid the sale of the property on death.

Downsides

On the downside, Mr Leggett says there are additional costs involved in buying and holding a property in a Sipp. As with any planned property purchase, he adds it can fall through but with a Sipp, the lost sunk costs are likely to be greater.

Plus a liquidity crunch, which could be caused by rent arrears or the absence of a tenant, could result in the investor having to contribute to the Sipp. In extreme cases, Mr Leggett says the Sipp investor may be forced to sell the property, for instance in the case of a few who have protection against the lifetime allowance which would be lost if they contributed.

Connected to the above, Mr Leggett says property by its nature is a very ‘lumpy’ investment – you can’t sell part of your holding in the way that you can with, say, funds or equities.

Property, if rented, also requires management. If the tenant is in rent arrears, Mr Leggett says these must be pursued vigorously. Even if the tenant is in effect also the investor - as business owner on one hand and Sipp member on the other - no special concessions are allowed.

Mr Leggett says: “It can be difficult to sell property and this may cause problems if the investor wants to take benefits from the fund or dies.

“Sometimes this can be resolved by paying benefits in specie (i.e. a change in ownership without sale and purchase transactions).

“If the investor becomes dissatisfied with the Sipp operator and wants to move to another, then that will involve a change of ownership, which is likely to be expensive.”

On the tax side, if a property is acquired from a member, Mr Tilley says the acquisition is treated as a disposal and thus a capital gains tax charge may apply on the seller.

Other issues

It is not advisable to invest your whole Sipp in one asset, says Claire Trott, head of technical support of Talbot & Muir.

Commercial properties unlike some other assets will incur ongoing charges, such as management fees and maintenance.

If the whole Sipp is invested and there are no liquid assets and the tenant were to leave, Ms Trott says the Sipp would be liable for all these charges and the insurance premium, which may increase because the property is empty.

A worst case scenario would mean the Sipp could end up having to sell the property at an inopportune time and therefore making a loss on the investment, she adds.

With Sipp borrowing, Ms Trott says this is generally from a high street source on a commercial basis, so there needs to be a plan to pay the loan back. She says the plan to repay the loan is usually using the income from the rental.