Property Investors

Commercial Property Tax Benefits For Investors

simon

Simon Misiewicz

17th May 2019

An article relevant to the tax year 2019/20

Your commercial property tax questions answered. You may be interested in our main article “buy to let tax for UK landlords”. This article discusses all the different types of tax that you need to be aware of as a UK landlord. Read Here for more (opens in a new tab)

What is a commercial property

Commercial properties in the eyes of HMRC is a non-residential building. Basically,  residential building is where someone lives. A non-residential building is where someone works. This is very important for Stamp Duty Land Tax purposes as we will discover later.

A commercial building (non-residential) may be in the form of:

– Shops

– Offices

– Warehouses

– Agriculture land / farming

– Petrol stations

– Restaurants

Types of commercial properties - Optimise Accountants

Town and Country Planning Order 1987 provides a list of use classes for each type of commercial property.  The following list gives an indication of the use classes:

A1 shops
A2 financial and professional services
A3 restaurants and cafés
A4 drinking establishments
A5 takeaways
B1 business
B2 industrial
B8 storage or distribution
C1 hotels
C2 residential institutions
C2A secure residential institution
C3 homes
C4 houses in multiple occupation
D1 non-residential institutions
D2 entertainment and leisure

From my perspective investing in both residential and commercial property is a way to diversify and reduce risk. The obvious caveat is that both residential and commercial real estate is still property related. As you will see below that the commercial values and financial viability are very different for each asset class.

Is commercial property a good investment?

There has been a downturn in the amount of money invested in buy to let residential properties. This is a direct result of the 3% Stamp Duty Land Tax surcharge from HMRC and Section 24 mortgage interest relief cap. Greater tax burdens on the residential property investors have led to a change to their investment plans. This is shown in an article written by This Is Money that suggested that the number of new landlords getting mortgages has plummeted by 60 per cent in the past decade. The sentiment that residential buy to let market is dead was echoed in the article written by Landlord Today.

Frank Knight opinion on commercial properties as an investment

Knight Frank in their article suggested that commercial property investment is a good idea. This is despite the fact that Brexit is still amongst us, at the time of writing. They suggest that commercial property investors ought to be looking at 7% return on their money. From my perspective, this is more money than you will get from a bank account. Do not forget that you should be looking at capital growth too. Knight Frank also highlight in their article the types of industries and commercial properties that will generate the very best returns. Make sure that you take some time to read their article.

RICS opinion on commercial properties as an investment

Royal Institution of Chartered Surveyors (RICS) has a different opinion. They point to Brexit as being a negative influence over commercial property investments and that of their tenants. You can read more about this in their 2019 quarter 1 analysis.

Savills’ opinion on commercial properties as an investment

Savills commented on the fact that there is a negative sentiment around commercial property investments because of Brexit. They also discussed in their article that there are some positives. With unemployment now at 4.2% people should be feeling positive. This is because of job security but also the prospects for wage growth. With greater confidence comes greater spending. Hopefully retail should start to see an increase in demand. Unless of course, the internet shopping takes over. Savills report was dated April 2018 and unemployment has since decreased further to 3.9%, which is even more positive.

Choose between residential and commercial property investments may be a little tricky given the above. One thing is for sure. Property is in your control and people that need to feel this will invest in property. Property investments, if done properly, can still generate more returns than bank accounts, bonds and gilts.

What are the benefits of owning a commercial property over residential?

 

Samuel Leeds of Property investors discussed the difference between residential property investing and commercial property investing.

There are a number of differences when investing in commercial properties to residential properties:

– A tenant in residential property will normally be on a 6-month Assured Shorthold Tenancy (AST). In commercial property, a lease may be drawn up to many years. There may be a break clause within the term. As such there is greater certainty for the investor of receiving rental income on their commercial properties.

– Residential landlords will normally be required to provide maintenance to the property. These items are appliances no longer working, gas or electricity issues, tiles on a roof breaking etc. A landlord of commercial properties may pass these costs onto the tenant.

– Market Values of residential and commercial properties will vary to one another. Residential prices will fluctuate based on a number of factors. The first one being the state of the economy and unemployment. Lower levels of unemployment will suggest that people have the funds to put down a deposit on a house. If interest rates are low then people can borrow more (affordability) and buy more expensive houses. Commercial properties may increase/decrease because of industry and its industrial economic state. Interestingly, businesses are asking employees to work remotely. This is having a knock-on effect on the number of required offices.

– You can use your pensions to invest in commercial property. You are not allowed to use your pensions to invest directly into a residential property. This provides an opportunity for people that put money into their pensions to invest in property and take control of their investments. A good investment strategy is to own a building that your own business requires. Examples being a warehouse or office space or indeed a shop. The cost of rent is tax deductible for the company. The rent paid into the pension fund accumulates without any tax burdens. We will discuss this in more detail later.

Downsides in buying a commercial property

One of the downsides to commercial property is the initial price. A 2 bedroom house will cost significantly less than a 10 story flat. You will need more money to get into commercial property investing. That said there are plenty of smaller units where dentists and accountants work.

Download your buy to let tax guide here, written by our property accountants

What are the tax benefits of converting commercial property into residential?

We highlighted more Stamp Duty Land tax savings in another article for both property investors and property developers.

Stamp Duty Land Tax savings when buying a commercial building to convert it into residential

We see that Local Authorities are giving permitted development rights to convert offices into residential dwellings (homes). This means that you do not have to go through the whole planning process. Commercial property prices are not too dissimilar to residential prices to make this worthwhile.

Residential properties – Stamp Duty Land Tax rates

Up to £125,000 Zero
Over £125,000 to £250,000 1%
Over £250,000 to £500,000 3%
Over £500,000 to £1 million 4%
Over £1 million to £2 million 5%
Over £2 million from 22 March 2012 7%
Over £2 million (purchased by certain persons, including corporate bodies) from 21 March 2012 15%

Per HMRC’s website a 3% Stamp Duty Land Tax surcharge that must be paid by property developers when buying a residential property. This means that the starting Stamp Duty Land Tax charge on a property costing more than £40,000 will be 3%. The top rate of Stamp Duty Land Tax to be paid by a property developer on a residential property is 18%.

Stamp Duty Land Tax (SDLT) is charged at 15% on residential properties costing more than £500,000 bought by certain corporate bodies – or ‘non-natural persons’. These include:

– companies
– partnerships including companies
– collective investment schemes

Non-residential properties – Stamp Duty Land Tax rates

Up to £150,000 Zero
Over £150,000 to £250,000 1%
Over £250,000 to £500,000 3%
Over £500,000 4%

The cost of Stamp Duty Land Tax of a commercial building is far less than that of residential property. If you purchased a commercial building, which you intend to convert into residential at a cost of £400,00o the SDLT would be £9,500. If you purchased a residential property for £400,000 the SDLT would be £22,000. This is a tidy saving of £12,500.

Value Added Tax (VAT) saving when converting commercial buildings into residential. 

As we wrote in another article that there is a VAT saving to be made when converting a commercial building into residential. All the VAT on the direct labour and material costs to do with the conversion will be reduced from 20% to 5%. There are exceptions so please seek professional advice before taking any action.

Any professional fees such as planning, architecture, project management etc will remain at the standard rate of VAT being 20%. There is no need for the property investor/landlord to be VAT registered as it is a simple reduction on the supplier’s invoice. As we outlined in our previous article that the tradesperson has to buy and fit the materials. You as the property owner may not buy the materials and claim back the 15% overspend on VAT.

Normally, you would have a VAT cost of £20,000 if the direct labour/materials cost of the refurbishment is £100,000 excluding VAT. If you take heed of this article the VAT would be reduced to £5,000. This is another tidy tax saving of £15,000.

The above SDLT saving of £12,500 may now be added to the VAT tax saving of £15,000. The total tax saving of converting a commercial building into residential is now £27,500.

I am surprised that there are not a lot more people carrying out this work. Unless of course, they are not aware of these tax savings of converting commercial buildings into residential.

We discussed how property investors may reduce Stamp Duty Land Tax in another article.

Example of converting a commercial property into residential – 8 Bedroom Commercial to HMO Conversion by Mike Stenhouse

Here is an interesting insight from Mike Stenhouse who runs Inside Property Investing podcasts. He and Victoria converted a commercial building into an 8 bedroom House of Multiple Occupation.

As well as loving the design of this HMO conversion, I’m also pretty pleased with the numbers.

We purchased the two offices for £210,000 and our total costs including renovations, stamp duty, legals, lease payments to the landlord, and everything else was around £180,000, giving us a total spend of £390,000. It’s a lot of money to create an 8 bedroom HMO in Stockport, but we have really transformed this building and shouldn’t need to spend a penny on the structure of the building for decades.

All rooms rented in the space of a few weeks, ranging from £500-£650 per month, giving us a total gross monthly income of £4,500. Based on that figure and other valuations we’ve had in the area we’re hoping for an end value of £420,000. That would leave £75,000 tied up in the project, and give us a return on that investment of 30-35%.

Read Mike’s blog post about converting a commercial property into residential. 

Hidden Value Added Tax (VAT) charge when buying a commercial building

One area that you need to be careful of is the potential VAT on buying a building. If you were not careful and purchased a building for £400,000 then you could face a nasty surprise of a VAT charge of £80,000. This would easily wipe out the tax savings achieved from the above. As we can see from the other article that the VAT charge when buying a commercial building may be removed if you are converting it into residential. The form that needs to be completed by the seller is called a 1614D. This form disapplies the VAT charge and saving you the £80,000 VAT bill.

There are conditions to be met before the 1614D form may be applied, ensure you take professional advice on this point.

Avoidance of paying VAT on a commercial building if it is a Transfer Of Going Concern (TOGC)

As HMRC’s website shows that the purchase of a commercial building that is less than three years old would be subject to 20% VAT unless sold under a lease (not freehold).

There is another way to avoid the VAT charge when buying a commercial building. If the buyer was to buy a commercial building and utilises it in the same way that the seller did then there is a Transfer Of Going Concern (TOGC). This is exempt from VAT and is therefore not chargeable.

Where the business being transferred does not contain any land and buildings (for which further conditions may apply as set out below).

1. the supply must be a supply of the assets of the seller’s business (or part of it) as a going concern
2. the buyer must use the assets transferred in carrying on the same kind of business as that carried on by the seller
3. if the seller is a taxable person, the purchaser must be a taxable person or as a result of the transfer become one, and
4. if only part of a business is being transferred, that part must be capable of separate operation

How is commercial property taxed? 

Profit on either residential or commercial property is tax at the same rate of income tax or corporation tax. This is dependent on how you choose to structure your property investments. Some people may invest in property in their own name and will be taxed at 0%, 20% (basic rate taxpayers), 40% (high rate taxpayers) or 45% (additional rate taxpayers) depending on their income levels as shown by HMRC’s website. At the time of writing income tax is charged as follows:

– 0% for income up to £12,500

– 20% for income from £12,500 to £50,000

– 40% for income from £50,000 to £150,000

– 45% for income over £150,000

If you hold a property inside a limited compamny the corporation tax rate is currently 19%. We know from HMRC’s website that the corporation tax rates will drop to 17% from April 2020.

There is an issue with the above. We are ignoring the fact that people may have mortgages on their residential property investments. As shown in our article that Section 24 mortgage interest relief cap will have a damaging effect on residential property investor’s tax status. This means that residential property investors will pay more tax on their residential property investments than they will do on their commercial properties. This is because residential property investors will not be able to offset 100% of the mortgage interest costs against their property income.

Capital allowances on commercial buildings help reduce tax

It is also likely that commercial property investments will benefit more from Capital Allowances. These tax benefit costs are for the plant & machinery and Fixtures & fittings within a property. These items will typically be valued by surveying companies such as Six Forward. The value of items found will be used to generate a capital allowances claim.

These items will then reduce your income tax or corporation tax depending on how you purchased the property. It is possible to claim the full cost of plant & machinery and Fixtures & fittings within a property within the year of acquisition. This is because of HMRC providing investors with an Annual Investment Allowance (AIA). You can offset the lower of the plant & machinery and Fixtures & fittings and the annual investment allowance as shown below. More details may be obtained from HMRC’s website.

You cannot claim capital allowances on (as shown on HMRC’s website):

– things you lease – you must have a purchase lease agreement and not an operating lease
– buildings, including doors, gates, shutters, mains water and gas systems
– land and structures (bridges, roads, docks)
– items used for business entertainment

What specific items are allowed to be used as capital allowances within a commercial property?

Integral features are:

– lifts, escalators and moving walkways
– space and water heating systems
– air-conditioning and air cooling systems
– hot and cold water systems (but not toilet and kitchen facilities)
– electrical systems, including lighting systems
– external solar shading

Fixtures
– fitted kitchens
– bathroom suites
– fire alarm and CCTV systems

At the time of writing, you were able to get a £1m tax benefit from the Annual Investment Allowance.

More details about capital allowances may be found on HMRC’s website

How capital allowances help you save tax on your holiday let

Please read our other article if you are looking for tax and VAT savings on your holiuday let.

You could claim Annual Investment Allowance if the year that you purchased furniture inside your holiday let for £20,000. The £20,000 cost would benefit from a current day tax rate of 19% is a tax saving of £3,800. This tax benefit will drop to £3,400 when the corporation tax rate falls from 19% to 17%.

If you own a holiday let in your personal name and a 40% taxpayer the tax saving would increase to £8,000.

One the face of it saving £3,800 on your holiday let may be an achievement. However, if you use a company like Six Forward they would do a full valuation report on the property. They would be able to identify the hidden tax savings inside of your holiday let.

It is advisable to work with companies like Six Forward as they will value the property. Upon their inspection, they will be able to identify the additional items that you cannot see. These items as highlighted above being electrical heating and lighting systems (including wires). They will also identify plumbing systems that are all integral to the building. They have suggested that there are potential savings of say 12% of the property value.

Six Forward may be able to identify capital allowances of £48,000, being 12% of a building value of £400,000. These capital allowances for a high rate taxpayer would provide a tax saving of £19,200. This is an increased tax saving of £15,400 on your holiday let as a high rate taxpayer by obtaining a valuation report from Six Forward.

How do I buy a commercial property?

Before you buy a commercial property you need to know the demand and supply. There is no point in buying a shop if the shops are all closed in the local area. This should signify to you that it will be difficult to get tenants. If shops frequently open with tenants but close soon after it would also signify that there is little demand. It is imperative that you match the demand and supply in each location you choose to invest in. Due diligence work will save you a lot of money.

You need to consider the industries that may be utilising your commercial building. If there is a trend of upcoming industries in a local area such as a growing hub of solicitors it may be an idea to buy an office for them to rent. There may be a fashion quarter of designer outfits that require shops, which the local community have demanded. If this is the case it may be worth looking at shops to buy for them to rent.

Getting a good team around you when investing in commercial property 

Once you have identified a local area with the right type of property it is important to put together an experienced team. If you are new to commercial property investments please ensure you work with someone that has significant experience in this field. They ought to be on hand to provide answers and guidance along your commercial property investing journey. They should be in a good position to prevent you from making costly mistakes.

You will need to find a good commercial estate broker. They will work with you to identify commercial property buildings that are in high demand and will give you a good rate of return.

It is imperative that you find a solicitor that is involved in commercial property investments. They will be able to support you when buying a property. They will also provide legal and professional guidance of writing up a lease with your tenants.

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Can you buy a commercial property inside a SIPP pension?

Before we go any further we need to stress that we are not financial advisors. You should seek out the services of a qualified wealth advisor in your local area. We recommend that you speak with two companies. Please note that we do not receive any commissions or kickbacks from our referrals. We refer you to others because we have used them in the past. They have also supported a number of clients in recent times. The first company is run and managed by James Lee of J L Wealth Consultancy and  Gay Hans who owns and manages AMG Wealth

You cannot buy a residential property within a pension. However, you can buy a commercial building inside a pension. Please remember that there are a number of tax benefits of investing in your personal pension. You can invest up to £40,000 into your pension per year. This is dependent on your earnings level. We wrote more about the tax benefits of investing in your pension in another article.

As A J Bell demonstrates that you can invest the money that is inside your pension into a manner of investments such as:

– Bonds

– Gilts

– Shares

– EFTs

– Commercial property

As you can see from the above list that you can put money into your own Self-Invested Personal Pension  (SIPP). This in turn then invests into a commercial property. The benefit of owning a commercial property inside your SIPP pension is the fact that the income generated from rent is not taxable. The amount of money that is received on disposing of the commercial property will also be free from tax if held inside a pension. This means that the capital growth of the building is therefore exempt from tax.

Many readers out there may not have sufficient funds to buy a commercial building outright. One thing for you to note is that your SIPP pension can use the leverage of mortgage products of up to 50%. If you wish to buy a commercial building in your SIPP for £250,000 then rest assured that £125,000 may be borrowed. There are other terms and conditions that you need to adhere to and this is where we suggest you take professional advice from a wealth manager.

The alternative to using banks as leverage is joint ventures. You are able to pool multiple SIPP pensions for you to buy a commercial building. This is a great idea for medics that wish to use a larger facility to gain economies of scale.

If you want to know more then please read our “buy to let tax tips for UK landlords” article

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