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Tax efficient development of property in a pension

In a world of reduced pension contributions, there can be significant advantages to developing property within a pension. Claire Trott, head of Pensions Technical, Talbot and Muir, explains

One of the advantages of holding commercial property in a SIPP or a SSAS is that it is possible to use the funds within the scheme to add value to the asset. The increase in value is protected against capital gains tax and the funds used have received tax relief on the way into the scheme. Even if a mortgage is required to complete the project this can be done within the scheme (up to a maximum of 50% of the net value of the assets, less any existing borrowing). The rental income that is received into the scheme tax free is used to pay the mortgage, making the whole process very tax efficient.

As with all things related to pensions, there are a number of different issues that need to be taken into account when undertaking any development work and these should be considered before embarking on any project.

Bare land

There is still a significant amount of bare land available for purchase and this can be bought within a scheme, even initially without a purpose. The asset can be held in anticipation that it will go up in value or with thoughts of development. Historically, bare land was purchased in areas that large supermarkets may want to develop and then sold to them at a high profit, unfortunately this easy win is less common these days as the supermarkets are not expanding in the way they once were. This does not mean however that there aren’t opportunities available, but these are most likely to exist for those who know the local market, so they aren’t caught out owning a piece of land that has no value to the scheme in the long term.

Planning permission

Obtaining planning permission can be a great way to enhance the value of a piece of land, it could be residential planning permission on some bare land that can be sold for development or it could be planning permission to convert or extend a property that is already held within the pension scheme. The pension scheme can fund the application for planning using tax relieved savings and the increase in value will be protected from a capital gains tax charge on sales because it is held within a UK registered pension scheme.

Residential issues

It is actually possible to buy a piece of bare land and develop it into a residential property within a pension scheme. The scheme cannot hold residential property, so it is good practice to have a plan in place to sell the asset before it is habitable. This is because HM Revenue & Customs (HMRC) deem a property owned by a pension scheme to be residential when it is or becomes ‘suitable for use as a dwelling’ so if the development has not been completed then it has never been suitable to live in and cannot therefore incur any taxable property charges.

It is also possible to convert all or part of a commercial property into a residential one. If the converted part falls into the residential exemptions, within HMRC’s taxable property guidance, then this isn’t a problem, but if it doesn’t it will need to be sold before it is deemed to be suitable for use as a dwelling. Residential exemptions include commercial properties that have a residential element that has to be occupied by a manager by virtue of their contract to manage the commercial part of the property (it should be noted that the manager cannot be connected to the member of the scheme or the exemption is invalid).

Arms length transactions

There is nothing to stop the development work being carried out by the member or their company but they have to charge the pension scheme a true commercial rate for the work carried out. To ensure this is the case then the pension scheme should make sure that other quotes are obtained to ensure that the rate they are being charged is not either more or less than would be charged by a third party contractor. If this is not adhered to then any over or under payment would be treated by HMRC as an unauthorised payment and would incur significant tax charges.

In many cases the work will be conducted by a independent contractor and, therefore, the pension scheme will want to ensure that it is getting good value for money, so again it is good practice to ensure that more than one quote is obtained.

Environmental issues

There can be opportunities for land that has previously been used for another purpose. Many will steer clear of this type of land because of the danger of environmental issues from the previous use. This shouldn’t be a problem provided you are fully aware that they exist and can take precautions to mitigate any issues that may arise in the future. A desktop environmental survey will be conducted when any land or property is purchased and should this show any red flags, then a more detailed search will need to be conducted. Unless there are really serious issues with the land, then it is usually possible to insure against any future liability. The issue with things such as contamination is if the culprit can’t be found that contaminated the site in the first place, then it will be down to the owner, the pension scheme, to put it right. It isn’t worth putting the client’s retirement at risk so having insurance in place is key.

Is it all worth it?

The issues and hurdles that arise when developing land or property within a pension scheme can in many cases far outweigh the benefit to the scheme and scheme members. The increase in the value of the scheme and the security that an asset, such as property, can bring to the members of a scheme is even more popular in the world of reduced pension contributions, tied in with the ability to pass pensions down through the generations. Property development shouldn’t be entered into lightly and the key is to take expert advice in all areas.

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