Put Your Property into a Pension - and Get a Tax Refund

Introduction
Most people are aware of the generous tax reliefs available for personal pension contributions. But did you know that you can put bricks and mortar into your pension pot - and get a tax refund in cash for your trouble?

Whilst this brief article will concentrate on the main tax aspects of a property-based pension contribution, there are many other factors to consider – this is a specialised field – and professional advice beforehand is essential.

Just like with an ordinary personal pension contribution in cash, the value of the property secures a corresponding cash supplement from HM Revenue & Customs – and a higher rate taxpayer will also obtain up to a 25% tax credit through self-assessment. 

Just like with ordinary pension investments in stocks and shares, a property based fund has the opportunity to receive income (in this case rental income) free of income tax. When the pension fund sells the property, any corresponding uplift in property value should be free of capital gains tax (CGT).

Note that these personal tax benefits derive from personal ownership of the property. The rules work differently where, say, your company owns the property – although here again, a property transfer into a pension scheme can potentially release significant funds for the benefit of the company, albeit under quite different arrangements.

Bill is a successful self-employed photographer and owns his own lock-up business premises, worth £80,000. Although he already has a pension scheme, he has recently made only modest contributions to his scheme in the last few years. The property cost him £75,000 in 2008 and has not increased much in value in the few years since thanks to the depressed property market but he is confident that, in the long term, the property’s value will improve. This year, he has over £100,000 of earnings subject to higher rate tax.

If he transfers his business premises into a personal pension fund:

This example is quite contrived but is designed to illustrate the potential benefits – and there is flexibility to accommodate more realistic scenarios, as we shall see later.

Once the property is transferred, it belongs to the pension scheme, not to Bill (in the above example), although he may well still be involved in the administration of his pension fund. Although the scheme’s main goal is to maximise the value of the fund available to Bill on retirement, it will not be purely Bill’s choice as to how best to achieve that – although this applies to pension funds generally.

The property will have to be properly valued so that the equivalent monetary contribution can be established when the property is transferred in.

Once transferred, the pension fund will ordinarily charge a market rent to its tenant(s). Bill should be confident that he can afford to pay the rent – but it will in the end help to boost his pension fund. 

Bill doesn’t have to be (or to remain) the tenant, although it is often convenient for that to be the case. If Bill wants to move to larger premises, he can – the pension scheme will just have to find a replacement tenant.

There are administrative costs to running a property-based fund, usually financed through the rental income it generates.

Bill has to have ‘relevant earnings’ in order to secure the favourable tax treatment – broadly, earnings which can be pensioned. This is unlikely to be the case for someone who ‘only’ invests in property. 

Bill also has to have sufficient overall taxable income in the year that the pension contribution may be set against, which is why we said tax relief of ‘up to’ 25% of the property value, even though in certain favourable circumstances the credit can actually exceed 25% of the property’s value.

There are annual and lifetime caps to the pension contributions and funds that can rank for tax-favoured status. The annual allowance is £50,000 per year and this is due to fall to £40,000; (although it is often possible to ‘roll up’ unused relief from earlier years – as in the example of Bill above); likewise the personal lifetime allowance is due to fall to £1.25 million in tax-favoured funds.

Ordinary residential property is ineligible to be held in a personal pension fund: it has to be commercial property, although not necessarily offices or factories. Some residential-type properties are eligible, e.g. student halls, hotels.

There may be VAT implications for the transfer of a commercial property although these are normally tax neutral, if planned properly. Particular care is required if participating in some of the VAT schemes.

The transfer of a property to a pension scheme will almost certainly trigger a disposal for the purposes of capital gains tax, so care is needed to ensure that any immediate CGT cost does not outweigh the immediate and long-term benefits of a transfer.

Some of the conditions outlined above might seem to place severe restrictions on the value that can be put into property-based pension investments – or require very substantial incomes. But there are one or two ways in which the rules can ‘flex’ to accommodate:

(a) Multiple investors – it is possible to have joint pension funds, such as between husband and wife, business partnerships, or ‘syndicates’. This allows each member to have an appropriate proportion of a higher-value property and still qualify for the tax benefits. Of course, having more than one investor can potentially lead to greater complexity in administration, and there should be provision for disagreement between members so that different requirements can be accommodated later in the life of the scheme.

(b) Part interest – it is not necessary to transfer the complete interest in the property in one go. A part-interest may be transferred instead – Bill could have transferred a 25% interest only, if his relevant earnings or higher rate tax bill were smaller, or if the property were more valuable. Bill could then transfer another part interest to his fund later on – again eligible for tax relief.

Depending on the circumstances, it may be possible to utilise entrepreneurs' relief and effectively cap the CGT on any uplift in value on transfer in, to just 10%.

In the vast majority of cases, this must be seen only as a long term investment so the property has to be suitable: any future disposal by the pension fund may be tax free but if there's a substantive risk of a fall in value, bear in mind that there will be no tax relief for any capital losses.