Using SIPPs to Hold Property: Landlord and Tenant Issues

Our SIPP and SSAS team are seeing a range of issues arising from the holding of property in self-invested personal pension (“SIPP”) schemes. In this article, Pensions Disputes Partner Suzanne Padmore, Real Estate Disputes Senior Associate Rebecca Lee and rural residential specialist Maddie Dunn, have shared notes to provide a back-to-basics overview of relevant considerations.

Commercial property is an alternative asset for investors seeking long-term investment, which can be held either as a direct holding or indirectly through an investment vehicle. In this context, property includes not just ownership of land and buildings, but also rights and interests over property.

There are various complexities to take into account before using a SIPP to invest in property. In this article, we examine some of the issues connected with direct holdings in commercial or exempted residential property which the investor should discuss with their financial adviser before becoming a landlord through their SIPP. 

1. What is a SIPP?

A SIPP is a type of personal pension scheme (i.e. not an occupational scheme established by a sponsoring employer). As the name suggests, a member of a SIPP can determine their own investment strategy, with a much wider array of investment options than occupational or more traditional personal pension schemes.

The SIPP operator will be authorised by the Financial Conduct Authority and the scheme will be registered with HM Revenue & Customs to take advantage of the tax benefits available to pension schemes. Whilst the operator carries out the administration for the SIPP, it will often use a trustee company from the same group to hold the assets.

2. How is property held in a SIPP?

Typically, commercial property is either held in an individual member in their own SIPP fund, or a syndicated arrangement by which several members club together to jointly purchase property with their combined SIPP funds.

The legal owner of the property investment will be the operator’s trustee company. Historically, some schemes allowed the member to be a joint owner of the property, effectively becoming the joint trustee over it. However, this type of arrangement is rarer nowadays.

In most cases, residential property cannot directly be held by a SIPP, but there are some exceptions to this rule, including real estate investment trusts (or “REITS”), specific types of employee accommodation, student halls of residence and some residential property let together with business premises.

Although a ‘SIPPable’ investment, some SIPP platforms are reluctant to allow commercial or exempted residential property to be held on their platforms due to the extra administration and specialist knowledge required in facilitating the day-to-day management of the property.

Any “unauthorised property” (i.e. not in line with the HMRC Regulations), will give rise to an unauthorised payment charge against the value of the property, payable by the member. In addition to the unauthorised payment charge, a member may expect a surcharge and a scheme sanction charge on the scheme administrator. 

In some cases, business owners fund the purchase of their own business premises through a SIPP, and in turn the rent is paid directly into the SIPP, accumulating free of income tax and CGT, and can be used towards other investments in the SIPP.

3. Advantages of holding property as a direct investment

The benefits of holding appropriate property in a SIPP include:

• Tax Advantages:

- Access to the benefits of the SIPP’s tax wrapper, although SIPPs are not exempt from all UK taxes and specialist advice may be needed in individual cases.

- Selling a property held in a SIPP does not trigger capital gains tax (“CGT”) as when the property is sold, any growth in the value of the property enjoys the CGT exemptions available to registered pension schemes.

• Cash Injection: using the SIPP to buy a property from the business will allow the illiquid asset to be replaced by cash which the business can use for commercial purposes.
• Income Stream: any rental income from the property can be used as a pension, subject to pension tax rules.
• Capital Growth: the property is an investment in its own right. Rental income which is not used to provide a pension can be re-invested in different assets – and is not paid to an unconnected landlord.

4. Holding commercial property in a SIPP – landlord and tenant considerations

Commercial property can be a very effective asset in a portfolio but is not without risks. As with any high-value purchase, there are various complexities to consider before investing in commercial property through a SIPP.

A common hurdle when holding a property through a SIPP is where the terms of the lease require the parties to carry out a periodic rent review. Leases usually contain express provisions that allocate the burden of triggering a rent review on the Landlord. Rent reviews allow the periodical adjustment of rent at the date of the review (usually every three to five years).

For many, buying a commercial property is purely an investment vehicle, to be rented out to a third party, on an arm’s length basis. For others, it is purchased as a property for their business to occupy. 

Many SIPP pension scheme properties have ‘connected party’ tenants, and it is easy for the tenant to overlook the fact that the property they lease is owned by the pension fund, and not themselves or their company.

A connected party is:

• Scheme members, their spouses or relatives;
• A partnership, where one of the partners is a member or relative of a scheme member; or
• The member’s employer.

To ensure compliance with tax legislation, a SIPP holder must ensure that connected party rent reviews are always on an arms-length commercial basis, to avoid any additional tax charges being imposed by HMRC. SIPP providers therefore require the landlord and connected party to engage a third party RICS registered surveyor, who will determine the open market rent value.

One of the key decisions that will need to be made is whether to have an independent trustee or whether the assets are managed by the member as a co-trustee. With a managed SIPP the SIPP operator will usually oversee the scheme acting through its trustee company, and normally at the direction of the member. If there is a sole trustee then the property title will be held in the name of the trustee only, whereas in a co-trustee SIPP the legal title will be held by the trustee and the member.

The SIPP trustee, who holds assets in the trust for the beneficiaries (i.e. the members and their survivors) will have certain requirements and obligations to ensure that the scheme is run properly. If the operator and trustee are separate the SIPP trustee will normally be a ‘bare trustee’ i.e. it will have a minimal role and the operator takes most decisions relating the SIPP.

5. Common pitfalls when looking to hold commercial property in a SIPP

With the freedom and flexibility of a SIPP, comes more responsibility and as with any investment, there are risks. 

Perhaps most importantly, the value of an investment can go down as well as up, so if the property falls in value or there are void periods, the SIPP is likely to substantially fall in value.

We consider below the additional risks where a commercial property is held in a SIPP.

• Maintaining Rent: failure to pay the commercial amount of rent for a property rented by a member would lead to an unauthorised payment tax charge on an amount equivalent to the shortfall.
• Void Periods: if there is no tenant in occupation, the absence of rent payments would have an impact on the value of the total SIPP fund as well as restricting the amount of cash available for expenses.
• Additional Cost: fees and charges will need to be paid on top of the typical costs in purchasing a property – which could potentially put the member at a loss if the transaction fell through. Total fees and other expenses could end up as a higher percentage of the asset’s value than with other types of investment, particularly for small funds.
• Illiquidity: if market conditions are undesirable at the time of eventual disposal, it may be difficult to find a purchaser, potentially causing delay to retirement. The members will also need to ensure sufficient cash is kept within the SIPP to meet the expenses of ongoing management.
• Lack of diversification: given the cost of property purchase, a member may need to use the majority, if not all, of their SIPP fund for direct investment in commercial property, leaving little or no room for other types of investment.
• Avoid a Scam: overseas commercial property developments are one of the commonly used investments in SIPP scams – be cautious with the property invested in.
• Decision-making amongst the SIPP members: co-ownership of property will require co-operation between the members. A formal syndication agreement should be considered to agree the basis on which decisions should be made, particularly when the property is occupied by a connected party.
• Transactions on an arms-length commercial basis: all transactions with the members must be carried out on arms-length commercial terms. No benefit should pass to a member from the property unless it is authorised by tax legislation. HMRC will treat the difference between the amount actually paid and the commercial terms as an unauthorised payment with serious tax consequences for both the member and the scheme administrator.
• Landlord obligations: the SIPP’s trustee company will be liable for all the legal obligations applicable to the landlord and the costs of compliance will be passed on to the member’s SIPP.
• Borrowing limits: tax legislation limits the total borrowing available to a SIPP, normally to 50% of the value of the assets it holds.

6. Holding residential/mixed use property in a SIPP

There are limited circumstances in which residential, or partially residential, property can be directly held in a SIPP. These include:

• Commercial properties with a residential part such as a flat over a shop that is leased from the SIPP together with the shop, with the flat occupied by the shopkeeper in connection with them operating their trade from the shop. In that scenario the shop is treated as commercial property and the flat above is exempted (i.e. permissible) residential property. The let cannot be to a connected party tenant, and the flat must be used in connection with the business premises.
• Employee accommodation for example a commercial property that also encompass a caretaker or security guard’s flat. Here too the employee cannot be a connected party and must be required as a condition of employment to occupy the property.
• Student halls of residence – provided that the halls comply with HMRC’s rules as to what counts as a hall of residence the property will not be treated as “residential”. It’s really important for SIPP landlords to carefully review how halls of residence are designed and occupancy arrangements put in place both to avoid issues with HMRC and the risk of inadvertently creating tenancies.

7. Current risks of holding residential and mixed-use property

In addition to many of the risks attached to commercial property (void periods, costs, illiquidity) residential property may, depending on precisely how it is occupied also present the following additional complications:

• Where the occupation is a tenancy, more onerous landlord requirements and restrictions apply, for example in relation to minimum energy efficiency standards, gas and electrical safety, smoke and carbon monoxide alarms and tenancy deposit schemes. Failure to comply has serious consequences which may include fines, rent repayment orders and restrictions on a landlord’s ability to give notice to terminate tenancies.
• Where the let comprises a residential unit and related commercial unit termination provisions may not wholly align, particularly as the arrangements will be governed by different legislation. This creates a management burden.
• Restrictions on what fees can be legitimately charged to tenants.
• Risk of inadvertently creating tenancies in circumstances where the arrangement is intended to be a licence. An example of this would be employees housed for convenience rather than because it is essential they live in the provided accommodation to be able to do their job. That can mean that the arrangement takes effect as a tenancy (usually an Assured Shorthold Tenancy at the moment) rather than the intended service occupation agreement. This has consequences for termination and also means the SIPP may have landlord responsibilities that it did not expect to have and so has not fulfilled.
• Challenges in regaining possession - residential occupiers cannot be evicted without following due legal process. This typically means a court application for a possession order. While, at the moment, it is usually possible to regain possession fairly straightforwardly, the process still involves time and cost.

8. Increased complication if the renters' rights bill becomes law

• At the moment, tenancies of residential properties granted by SIPPS will usually be Assured Shorthold Tenancies. That has been the default form of residential tenancy since 28 February 1997 (and could be opted into prior to that date). Assured Shorthold Tenancies can be terminated without reason, by the landlord giving 2 months’ no fault notice. We expect Assured Shorthold Tenancies and no fault notice to be abolished in the near future if/when the Renters’ Rights Bill becomes law.
• The Bill will make assured tenancies the default. Assured tenancies can only be terminated if specific grounds for possession are made out. That can mean the tenant is in for life, unless they breach the tenancy or chose to leave. Assured tenancies also carry succession rights.
• There are new proposed termination grounds that may assist if a tenancy is inadvertently created in a student or employee accommodation context. However it will be important for SIPPs to try to avoid inadvertent tenancy creation as that creates other risk as detailed above.
• None of the termination grounds would enable termination of an assured tenancy on the basis that a connected commercial lease is at an end. That presents a risk that a SIPP may have invested in an exempted residential property connected with a commercial premises but may not be able to compel the tenant to leave the residential property even if they have vacated the commercial premises. This could mean the property no longer complied with the terms of the residential property exemption and could remain non-compliant on a long-term basis. It is not clear yet how HMRC would treat that scenario, or whether that might risk surcharges or scheme sanction charges. There are mitigation steps that can be taken, but many relate to how the tenancy is structured when it is granted so need to be considered from the outset.
• The Bill also increases penalties for landlord non-compliance with legislative requirements, introduces new registration requirements and increases the standards homes need to meet. This all means that landlords’ cost base and risks will increase if the Bill is enacted.

Final comments

Where it is properly managed, commercial property is capable of being a very effective pension scheme investment. Residential property requires careful management, especially with risks set to increase in the near future. Again, managed with due care and attention, it can be an effective investment in the right circumstances.

Any prospective pension investor should take time to understand the legal requirements and the challenges they may have to face. Co-operation between joint owners is essential. Investors should plan ahead so that they do not meet any unpleasant surprises when they want to start taking retirement income.

To fully understand any investment vehicle, we strongly recommend specialist advice is sought from an authorised independent financial adviser. Staff at the SIPP operators’ offices will also be on hand to assist with administration queries.

The above article does not constitute legal or financial advice. It is based on our understanding of taxation legislation and HMRC practice at the time of publishing.

For those interested in the expected changes to residential rental property legislation, Maddie has prepared a series of short articles providing more information on the Renters’ Rights Bill. The first in the series can be found here.