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Putting Property Into A Pension

Lee Sharpe highlights some of the opportunities and possible pitfalls in investing in property – even residential property – via a pension scheme.

This article looks at the tax implications of putting property into a pension fund, and focuses in particular on recent developments in relation to ordinary residential buy-to-let (BTL) property. It should be emphasised that this is a potentially very complex area and professional advice should always be sought before investment decisions are made. 

Property and pensions

It is very common for pension funds to want to hold investments in property, perhaps because of their perceived reliability. Aside from portfolio diversity in ‘ordinary’ pension funds, it is quite common for people to invest directly into property as part of their retirement planning (‘my properties are my pension’). 

It is possible to invest in specific properties within an approved pension scheme, with all of the normal tax breaks that go with scheme approval, although direct investment in BTL properties is prohibited. This is unfortunate: A recent ‘This is Money’ article reported that, on average, BTL property has increased in value by around 1,400% from 1996 to 2014 – beating the returns on practically all other comparable investments. Of course, not all residential properties have made such outstanding returns. If they had, this article might perhaps have been written in the Caymans, rather than in Manchester!

Tax breaks for investing in property via pensions

Using an appropriate pension scheme, the investor can:

  • make pension contributions in cash as normal, and then use the accumulated funds to buy eligible premises which the pension fund will then hold. The contributions would get tax relief in the normal way - a personal payment of £800 goes into the pension fund, which reclaims £200 from HMRC, and the taxpayer can also claim higher rate tax relief (typically a further £200) on his or her own tax return, if applicable;
  • make an ‘in specie’ contribution of a property (or a part-interest in a property). This would still ‘count’ as a pension contribution: the scheme will be able to use the value of the interest in the property to get a contribution from HMRC, and the value of the contribution will still potentially be claimable for further tax relief on the individual’s tax return;
  • if the property is initially owned by the investor’s company, an ‘in-specie’ contribution of property may still be made; here again, the market value of the property will be taken as the amount of the contribution made - and generally eligible for tax relief in the business accounts. But it will count as an employer contribution, rather than one by the individual taxpayer;
  • the pension scheme will charge rent on its directly held property interests at normal market rates: this will ordinarily be tax-deductible in the accounts of the business tenant, but tax-free for the pension fund; 
  • if the pension fund sells any assets, they are generally exempt from capital gains tax (CGT); and
  • the pension scheme may also lend money back to the company within certain criteria, including:

o Interest must be charged; and
o Limits on amount/proportion of scheme funds that may be lent back to the business.

Limitations and pitfalls from a property perspective

Properties can be cumbersome because each parcel tends to have so much value. While it is possible to work with contributions of part-interests, it can be time-consuming and legally expensive to arrange.

If transferring property ‘in-specie’, there is likely still to be a CGT charge on any uplift in value on disposal, even if no money changes hands. 

There may be VAT and stamp duty land tax implications for a ‘transfer in’ of property – for instance, with a commercial property, it may be preferable for the pension scheme to register for VAT and to ‘opt to tax’ the property.

Although you can contribute up to £3,600 a year into a pension in any case, you generally need ‘relevant earnings’ (generally, earnings from employment or self-employment) in order to make larger contributions. Rental income alone does not count as relevant earnings. Note, however, that an employer contribution (such as from one’s own company) is not bound by relevant earnings.

Even if you have sufficient relevant earnings, (or an employer contribution), there is an ‘annual allowance’ which limits how much you can put into a pension and still enjoy all tax reliefs. It is currently £40,000 per annum, although unused allowance may be ‘rolled up’, for up to three years, giving four in total. However, this may still represent only a small part of the value of some properties, which is why part-transfers may still be useful. Each individual has his or her own annual allowance, so joint ownership can make even large property transfers viable.

Residential buy-to-let investment via a pension

While a pension scheme may not hold a BTL property as a direct investment, some relatively recent investment funds have opened which concentrate only on BTL properties, in the form of a real estate investment trust (REIT). REITs are property-oriented funds with shares which are traded on the London Stock Exchange, and which do not normally pay tax on rental income or capital gains on property sales.

If held in a pension scheme, this would mean that income from the BTL REIT holding would be free of income tax, and the sale of the holding would be free of CGT as well. It should also be practically much easier to match the amount of a desired pension investment to a corresponding number of REIT shares, than to a specific property in a directly held portfolio.

Holding a BTL REIT instead of investing in property directly would therefore seem to include the potential to access the excellent investment returns afforded by BTLs, even through a pension wrapper, although holding a publicly-traded investment would clearly mean handing over direct control over the quality and management of the fund’s housing stock (‘investments can go down as well as up’).

What about existing buy-to-let property?

Of course, if you already hold a BTL portfolio, selling up and converting it into a REIT holding may be expensive from a CGT perspective! 

However, one of the more interesting points about a particular BTL REIT I have seen is that I understand they are offering to swap their REIT shares directly for shares in companies which hold suitable BTL property stock – in other words, if you hold your residential properties in a company, then you could swap shares in your company for shares in the REIT. This transaction would be tax-neutral, in that a share-for-share exchange would normally postpone any CGT until the new shares were actually sold, or (say) transferred to your pension – it might well be easier then to manage contributions in stages and/or with joint holders and make use of several years’ worth of annual exemptions over time.

Practical Tip for putting property into a pension :

Pensions can be far more accommodating than many investors realise, and can offer significant opportunities for expanding a property business – through tax efficiencies or, in some cases, additional financing.

While it is possible to ‘put’ existing property (or part-interests in existing property) into a pension, care is needed to avoid the traps. As we have seen, it is now possible for a pension to acquire residential property via a share-type holding, potentially to access what has historically proven to be some of the best returns available.

The rules for pensions are changing and in many ways for the better, as they become more flexible. The market for pension products is still responding to changes in legislation. As pensions’ new flexibility offers more choice, competent professional advice is even more important to ensure that investors make the very best of what is on offer.

This is a sample article from the monthly Property Tax Insider magazine. Go here to get your first free issue of Property Tax Insider.