Commercial property in a pension: Benefits and pitfalls

We often hear the phrase “my property is my pension” – by which people mean their home or buy-to-let portfolio. But greater tax efficiency can be achieved by combining property with pensions. 

Putting a property into a pension has many tax benefits. Firstly, the money used to buy the property will have received tax relief on it. This makes saving for the property in the first place a lot easier, especially if there are employer contributions involved. The employer contributions will also have been able to receive corporation tax relief, which can be a real benefit for owner-managed firms. 

The usual taxes apply on the purchase of the property such as stamp duty land tax and VAT, although in many cases the VAT can be reclaimed by the scheme. 

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The real benefit comes when rental income is received into the pension scheme. It is tax-free, rather than subject to income tax as is the case if it has been received personally. These funds can be used to pay off a mortgage or build up additional funds for retirement and invested accordingly. If and when the property is sold, there will be no capital gains tax to pay on the increase in value.

All this makes for very efficient investing, but as ever with pensions there are other issues to consider, too.

Know the investment

The only asset permitted within a pension that does not incur tax charges is commercial property. Commercial in this context isn’t quite what some people might think. Some buildings (such as a bed and breakfast, or a holiday let) that are technically used as a business are not classed as commercial property when thinking about pension schemes. A good rule of thumb is to think that if you can live in it, it is residential. 

As with most pensions legislation, there are exceptions to the rule. Take a pub for example: most of these will have a flat above for a manager, so you would think that it would be classed as residential. But this isn’t the case when the flat is occupied by a manager who isn’t connected to the scheme member and has to occupy it by virtue of their employment contract. 

This sort of exception applies in many cases. However, a self-contained flat above a shop wouldn’t be allowable because it isn’t necessary for someone to live in it to manage the shop. 

In many cases, the property that is to be bought by the pension will be well known to the member, or at least the area and market will be. Pension providers rely heavily on professionals and members to be their eyes and ears with regards to properties, so knowing if there are likely to be any issues at outset is a really good start. 

A property management firm may be involved, or the pension provider may do this in-house, collecting rent and paying bills, but in both cases they won’t have day-to-day sight of the property. Instead, the member will, and they should keep an eye on any issues and report them if the tenants do not.