Finally, you can hold buy-to-let in your pension. Here's how
Swap your properties for shares in a new fund and your investment could grow tax free
Savers have not been able to hold residential property in a personal pension...until now. Photo: (c) Andrew Holt
By Richard Evans and Nicole Blackmore
Buy-to-let landlords may be about to have their biggest dream come true: being able to hold their properties in a personal pension.
This would make any future capital gains tax-free. Holding residential property in a pension has previously been impossible.
The change, which comes about as a result of a new fund that invests in rental properties, could even see investors receive a windfall from the taxman if the value of their buy-to-let portfolios is boosted by tax relief when it is put into the pension.
This manoeuvre, which would see investors swap their existing, directly owned properties for shares in the property fund, could suit small buy-to-let investors with a handful of properties. A different tax perk could benefit larger landlords who own their properties via a limited company, who may be able to defer some of their capital gains tax liability.
Either process would be complicated and would involve costs as well as benefits. Here we look at how they would work, first for small landlords and then for larger ones who already own, in effect, their own property company.
Smaller landlords who own their properties directly
How would I swap my properties for shares in the fund?
There are two ways. First, the fund, called Mill Residential, said it was interested in acquiring portfolios of buy-to-let properties directly from owners and paying them in its own shares. Alternatively, you could simply sell your buy-to-lets in the ordinary way and use the proceeds to buy shares in the fund, which is structured as an investment trust and plans to list on the stock exchange soon.
Wouldn’t this mean a big capital gains tax bill?
Yes, although this could be offset by the tax relief you make at the next stage, when you put the shares in a pension.
Tax would be charged at 28pc on any gains above the threshold for basic-rate income tax; below this level you would pay 18pc, although any other income is taken into account. Swapping your property for shares would give rise to a tax bill in the same way as selling it.
But you would be able to use the capital gains tax annual exemption of £11,000 and any additional allowance under the “principal private residence” rules if you had recently used the property as your main home, as many “accidental landlords” will have done.
So how does this tax bill get wiped out?
Once you have the proceeds of selling your properties, whether shares or cash, you can transfer them to a self-invested personal pension (Sipp). When this happens, the Sipp operator will automatically claim basic-rate tax relief from HMRC, and you can claim higher-rate relief via your tax return. You need to have paid sufficient tax that year to claim the relief.
If you swapped your property portfolio for shares in the fund, you can transfer them to the Sipp “in specie” or as they are. You can still claim tax relief on their value. If you transferred cash, you use it to buy shares in the fund.
Greg Kingston of Suffolk Life, the Sipp company, said shares in the fund would be eligible for inclusion in a Sipp.
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But my portfolio is worth hundreds of thousands. Surely I can put only £40,000 a year into a Sipp?
Yes, but there are two ways to boost the contribution. First, if you and a spouse own your portfolio jointly and both swap for shares, you could both contribute to (separate) Sipps. Second, you can carry forward previous years’ unused pension contribution allowances, as long as you belonged to a pension scheme at the time and had sufficient taxable earnings. This could boost each spouse’s total contribution to the Sipp to £190,000.
What happens once the shares are in the Sipp?
Just as with any other asset in a pension, your shares can appreciate with no liability to capital gains tax. Withdrawals would be taxed at your top rate at the time, although you could take advantage of next year’s new pension freedoms to take money out in the most tax-efficient way.
John Moret of More to Sipps, a consultancy, said: “This offers a flexible route to getting money out of property investments and dovetails nicely with the pension reforms.”
What are the pros and cons of swapping your properties in this way?
The pros include the ability to exit your property investments gradually once you own the shares. This could be ideal once you are retired. Actual properties can, of course, be sold only in one go. You will also no longer need to manage the properties yourself or employ agents, although the fund itself does incur costs. Another advantage is that for small landlords a single empty property could decimate their income, whereas in the fund there is likely to be a fairly consistent, hopefully low, level of vacancies.
The cons include the fact that you are giving up direct control of your assets and trusting the fund manager. Sipps also impose charges, while rates of tax relief could change in future.
Expert, independent advice is essential.
Larger landlords who own their properties through a company
What is the position regarding capital gains tax?
If you own the properties through a limited company, capital gains will normally be charged at the corporation tax rate of 20pc.
But it’s different if you dispose of these properties by exchanging shares in your company for shares in the fund. Under special tax rules, share transfers are tax free.
This means that you could defer your capital gains tax bill until you eventually sell the shares in the fund.
In certain circumstances, buy-to-let portfolios held directly, rather than in a company, may also qualify for such transfers. You would need to have a larger portfolio with 10 or more properties and to be personally involved in running the portfolio as a business, rather than as a passive investor. This is something of a grey area, however.
One landlord who could benefit from this is Fergus Wilson (pictured below), who, with his wife, Judith, has amassed a buy-to-let portfolio of almost 1,000 properties. Although they own their properties directly, rather than through a company, the exemption for large, managed portfolios could apply.
They are in the process of selling up for an estimated £200m and could face a capital gains tax bill of around £30m.
Mr Wilson said he would offer a “guarded welcome” for using a fund to swap property holdings.
“There’s always somebody who shows up with a handful of magic beans and says all you have to do is hand over your properties,” he said. “I would want to look at the details quite closely, but for landlords thinking of retiring, like us, it could be one option worth investigating.”
How do the tax perks affect the value of my buy-to-let company?
Because there is no capital gains tax to pay at the point of the exchange, the fund said it would pay more for properties acquired via a share swap.
For example, if a professional landlord has a company with property worth £4m and £2m worth of mortgage debt, the company’s net assets are £2m. If the capital gains tax due on the sale of the properties is £500,000, the company’s net worth is £1.5m.
Because of the capital gains tax deferral when the company is sold to the fund, Mill Residential said it would share the benefit by paying £1.75m for the company.
By taking shares in the fund rather than cash, landlords roll over their personal capital gain until they sell their shares in the fund.
Could you then transfer shares in the fund to a Sipp?
You could, but this would count as a sale and capital gains tax would become due.
How does the fund work?
Mill Residential is a “real estate investment trust” or “Reit”. This is a special type of company that owns income-producing real estate such as commercial or buy-to-let properties.
Capital gains and rental income are exempt from tax when inside a Reit, but holders of its shares are subject to tax when they sell.
Investors who buy shares in the Reit receive a proportion of the fund’s rental income through dividends. Reits must pay out at least 90pc of their taxable income as dividends to shareholders each year.
Investors are taxed on the dividends at their marginal rate, so a 45pc taxpayer receiving a dividend of £100 would pay £45 in tax.