One question we are often asked as tax advisers is what is the most tax effective way for an individual to purchase a commercial property, whether as an investment or for use in their business.
In classic tax advice style, the answer is – it depends!
There are so many variables that there is no one-size fits all answer to this question – you need to factor in not only short-term tax advantages but also your future plans for the properties when considering what the optimum holding structure might be.
So, let’s have a look at the various ways you might look at holding the property (ignoring VAT & SDLT for now as the VAT and SDLT treatment of commercial property won’t change that much by reference to the ownership structure):
Owning commercial property personally – in your own individual name
This route has the benefit of simplicity if nothing else!🥳
The income comes to you directly and you pay on the net rents after expenses.💷
If you sell the property then you pay capital gains tax on any gain you make but the proceeds but then cash left over (after paying off any debt of course) is yours to do with as you will.
So far so good but there are downsides.👇🏽
What if you don’t need all of the cash you generate from rents, or you are looking to reinvest the rental profit into other assets?
You may end up paying up to 45% tax on the rental profits meaning that you are losing a good slice of your profit.⚠️
Owning the property yourself also means that at best you would get relief for 50% of the value when Inheritance Tax becomes an issue – and only then if you use the property in a partnership or company you own.
If it is just a pure investment then the full value would be subject to IHT when you pass away.⚠️
Owning commercial property personally – in joint names
This option is much the same as in the first option, but you hold the property jointly with someone else – most often your spouse, partner or other family member.
The income and capital gain are split so the tax rate can be reduced, and on first death there will be no IHT assuming the half of the property is passed to the surviving spouse – but the second spouse still has the same IHT issue when they pass away…
Owning commercial property – in a partnership
Because of the way the tax system works the partnership approach is not far different from ownership in joint names although there might be the opportunity to vary how you allocate the income between partners.
Care is needed here though as HMRC are not always convinced a partnership exists when a married couple own an investment property!⚠️
A Limited Liability Partnership (“LLP”) may have the benefit of conferring some asset protection advantages but the tax outcome is generally the same.
Owning commercial property – through your trading company
Many business owners own their own trading premises in the same company that they operate the trade through.
This again is a fairly simple option but it does carry a degree of risk.⚠️
What if your trading company gets sued or runs into financial difficulty?
The value of your property would exposed to a claim along with the rest of the business – not impossible in an increasingly litigious society.
Separating the property out into a holding company which owns the trading company as well gives you the advantage of keeping things under one roof but reducing the risk you lose the value of the property to a claim.
Of course there is no rental income for you personally in this situation but you can still take cash out either by dividend or salary, and from an IHT point of view if the property is used in the trade of the company or group then you are maximising the availability of business property relief (assuming the other qualifying conditions are met…)
If the property is sold later then the company will pay tax on the gain and will own the cash, so getting that cash out can prove to be expensive from a tax point of view.💷
Owning commercial property – through an investment company or PSV (Personal Services Vehicle)
If you own a property as an investment rather than for use in a trade then you could look at owning that property through your own investment company.
The income will belong to the company and the company will pay tax at corporation tax rates.
Of course, there will be tax implications if you want to take the money out, but if you don’t need all the cash the property generates then you can store it up in the company and the only tax you will pay will be the corporation tax.
This is fine in the short to medium term but the question then becomes how you get the cash out in the future – this might well involve putting the company into liquidation once the property is sold.
Generally the proceeds of the liquidation are taxed as a capital gain but if the taxman thinks you are doing the liquidation to avoid paying income tax then they can still tax the proceeds as a dividend – so exercise caution!
Finally, there is a common misconception that owning an investment property through a company protects it from IHT – but sadly it doesn’t.⚠️
You can though turn the company into a family investment company and use it as a way to pass some of the growth in value to future generations.👨👩👧👦
Owning commercial property – through a trust
Trusts are another much misunderstood vehicle – at its most basic level a trust exists where a body of persons (the trustees) have the legal ownership of some property but are holding that property for the benefit of someone else (the beneficiary).
In isolation they are not an especially tax efficient way of holding assets as the income and gains of the trust are taxed at the highest marginal rate.
If the income is passed out to beneficiaries however then those beneficiaries may be able to reclaim some or all of that tax from HMRC.
Beware though – parents of minor children putting assets into a trust for those children will still be taxed on any income distributed themselves – so this is not an easy route to splitting income to reduce tax!⚠️
In the right circumstances though grandparents putting assets in trust for their grandchildren can give some tax benefits – but there are also big traps for the unwary.⚠️
Where a trust can really come into its own however is to protect assets and also potentially give some IHT benefits as well.
Let’s say you want to gift a property to your son or daughter but are concerned that they are not ready for the responsibility of owning the property.
You also worry that they may fall for someone “undesirable” and you don’t want that person to walk away with half of the value of the property in a messy divorce.🤵🏽👰🏽
Putting the property into a trust for their benefit allows you gift the benefit of the property but still maintain control as trustees – until you feel that the time is right for the next generation to own the asset outright.
Legal advice on what protection the trust does or does not bring is absolutely critical here.⚠️
Tax-wise there are limits to how much value can be passed into trust tax free but once those assets are in the trust they are outside of your estate for IHT purposes, although the rules are complicated and if you die within seven years then can still be IHT consequences of the gift into trust.
There are also extra charges on the value of assets in a trust – every ten years or when the asset leaves the trust.💷
Owning commercial property – in your pension
From a tax point of view there are a lot of attractions to owning a commercial property through your personal pension.
Any rental income generated is tax free in the hands of the pension (but still deductible for tax if paid by your business at a commercial rent for the use of the property) and a capital gain on the sale is also free from tax.
The value of your pension is also currently outside of your estate for Inheritance Tax purposes (although this is set to change from April 2027).
So far so very attractive 🥳
The downside of course is that the value is tied up in your pension until you are able to draw down on it – so this is a long term planning option for many rather than a short term fix.⚠️
It should also go without saying that you should never undertake an investment into a pension like this without firstly getting advice from a suitably qualified financial adviser – just because you get some tax benefits from the planning does not mean that it is the right thing to do when all other circumstances are taken into account.⚠️
Owning commercial property – no one size fits all solution!
So, there’s not an easy answer really to the question ‘how should I own a commercial property?’
There are many variations on the main themes set out in this article and choosing the right option for owning a commercial property is likely to come down to a balance of factors.
However, the key is being as clear as possible about your short, medium and long term plans for the property.
This will allow your tax, financial and legal advisers to provide you with a solution which best balances what may at times be competing factors…
One point above all though – it is much easier to put a plan in place before you buy the property than it is to make changes after so plan ahead and involve the right people early in the process!
If you would like any help or guidance about your commercial or indeed other property investment, please do not hesitate to contact the IN Team who will be happy to help!
If you are investing in residential property, including furnished holiday lets (FHL), you may be interested in our recent video answering your questions about recent measures announced relating to the tax treatment of FHLs and changes to SDLT for residential property, regardless of ownership structure:
For more videos on this and other similar subjects, please check out our YouTube Channel here: https://www.youtube.com/@INAccountancy/videos
