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Using your Sipp to buy property

The ability to buy property has always been one of the chief attractions of self-invested personal pensions (Sipps). Our national obsession with storing equity in bricks and mortar is well known; being able to do so within a tax-free environment is an added encouragement. Richard Mattison at the James Hay Partnership estimates the number of properties bought through Sipps at 35,000.

The classic case is when a dentist, say, uses his cash-rich Sipp to buy the premises of his practice. The business benefits because paying rent reduces the taxable income of the business, while freeing capital for investment. The dentist benefits because his business pays a tax-free income stream into his Sipp - income that can be used to invest in other asset classes - and because any capital gains on the property are also tax-free. And because the two parties are related, risk is reduced in both directions: the business has a stable landlord with no interest in selling up, and the landlord has a stable tenant he can rely on to pay the rent.

But problems arise as soon as you stray too far from this classic case. For a start, residential property is almost completely out of bounds for Sipp holders. The exceptions relate to homes that form an integral part of wider commercial properties, such as nursing homes or ski resorts.

Second, the relationship between landlord and tenant must not become too cosy, even if they are the same person. For example, struggling companies in need of working capital sometimes try to liquidate property assets by flogging them to the business owners through their Sipps. That is fine, says Francis Moore at European Pensions Management, as long as the sale price and rental payments are set at realistic market levels.

'This isn't a panacea for companies that are having trouble meeting rental payments. The tax authorities are getting much tougher about rental arrears, which can lead to legal action and eventually eviction,' he warns.

The idea of a landlord evicting his own business sounds slightly absurd, and Mr Moore says it has never known it get this far. But he has had to call in the lawyers to remind certain Sipp holders of his legal duty, as a trustee, to ensure the pension is not used as a bail-out fund.

The same logic applies to investors who are tempted to use their Sipps to buy a local library or post office slated for closure - whether or not inspired by David Cameron's 'Big Society' mantra. 'You might be more inclined to drink at the pub if you owned it,' points out Mr Mattison. But aspiring philanthropists need to adopt a rigorously commercial approach if HM Revenue & Customs is not to smell a tax-dodge, probably obstructing their charitable intentions.

Nor can Sipps be used for extracting ultra-high returns from rising property values through leverage, as was once the case. Before 2006, investors could borrow as much as 75 per cent of the value of a property and hold it within their Sipp. Now they cannot borrow more than 50 per cent of the Sipp's total value, reducing the effective loan-to-value ratio to 33 per cent if - as is typical - the entire fund is used for equity.

This regulatory tweak poured cold water on Sipp demand. But, given the subsequent collapse in property values, it looks like a rare instance of the authorities locking the stable door before the horse thought of bolting. One side-effect of the reform has been the rise of syndicates - groups of Sipp-holders clubbing together to buy a building, typically their joint business premises, that no single investor could afford.

For Sipp holders that don't have a property within the family business, the only way to get direct property exposure is to buy a classic income-generating commercial property - a high street retail outlet, for example. The yields can be pretty compelling, in some cases exceeding 10 per cent and untaxed within a Sipp. But that reflects the troubled market - the waning popularity of the high street relative to shopping centres and business parks as well as the dull outlook for UK retailers. Investors cannot expect rental growth or capital gains for some years - and there's always the risk of losing your tenant.

IC VIEW:

Buying property through a Sipp still makes most sense for business owners with real-estate assets. Those who don't fall into that category need to know exactly what they are buying and where the returns will come from - just like a residential buy-to-let investment. Otherwise they may end up with their Sipp dominated by a very lumpy asset that suddenly stops paying that tax-free income and is even harder to sell than a house.

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By Stephen Wilmot,
19 April 2011

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