Jennifer Adams considers some important tax benefits of investing in commercial property.
Whether to buy commercial or residential property depends on various factors, not least the more beneficial tax system for commercial lets and whether an individual or a company is purchasing the property. The government wishes to encourage commercial lets and therefore permits a more generous tax regime than residential lettings.
To HMRC, a commercial property is a non-residential building where someone works rather than lives. The most common types of commercial property are shops and offices, but broadly similar rules apply to such businesses as the retail and hospitality sectors, dentists, veterinary surgeries, sports centres, warehouses, factories, garages, schools, hospitals, and agricultural farms.
Possibly the most significant tax advantage for commercial property investment by an individual is the attraction of capital gains tax (CGT) business asset disposal relief (BADR) on disposal.
Business asset disposal relief
BADR is only available to individuals who own their business or shares in their trading company, on a capital gain arising on the disposal of a business asset (e.g., a commercial building) linked to (or takes place as part of) a disposal of all or part of a trade.
The main requirement for this relief is for the property to have been let out to a trading business profession or vocation, conducted commercially and with a view to the realisation of profits. Individuals must have been in business for at least two years before selling. The same conditions apply should the business close; BADR is only available when the business asset is sold within three years of the business closing.
The effect of BADR is to reduce the CGT rate charge from 28% (if the seller landlord is a higher-rate taxpayer) or 18% (if the landlord is a basic-rate taxpayer) to 10%. BADR is subject to a lifetime limit of £1m. The relief extends to disposals made within 36 months of cessation of trading, provided that the business qualified for the two years up to the cessation of the business.
Relief is potentially available on the disposal of a property that has been used both as a main residence and a business. BADR could be considered on that part of the gain not covered by principal private residence relief, subject to the relevant conditions being satisfied.
Charging rent
Many directors own the commercial property from which their company’s business operates. For the director, charging rent can be a tax-efficient method of extracting funds from the company rather than the more conventional salary, bonus or dividend route, although the director will be liable for income tax on the rent received less any rental expenses.
Importantly, charging rent can result in full or partial loss of BADR for the director when the property is eventually sold or transferred at the same time as the company shares are sold or transferred. By charging full market rent, the property counts as an investment asset and relief will be restricted. If the company pays rent at lower than the market rent, or paid rent since 6 April 2008 (when the rules changed), the proportion of the gain on which BADR can be claimed is restricted in proportion to the amount of rent paid.
Capital allowances
Capital allowances is another area where commercial property provides tax advantages for both the individual and company over residential property. Landlords who let residential property cannot generally claim capital allowances, either relating to the building itself or on any initial purchase of fixtures, fittings or furniture (although furnished residential lettings can claim under 'replacement furniture relief'). For commercial lettings, there is no such allowance – in its place is a system of capital allowances which permits claims on the purchase of certain fixed assets. The purchase cost of a commercial building does not attract capital allowances; but should the property require (for example) a new heating system, electrical installations, security systems, or other fixtures integral to the business operation, a claim can be made.
The 100% annual investment allowance (AIA) is available to both individual and corporate landlords; the cost of investment in standard plant and machinery is subject to a limit of £1m per accounting year. Corporate landlords may benefit from 'full expensing', whereby companies can claim 100% capital allowances on qualifying plant and machinery investments and 50% first-year allowance for special rate pool expenditure (e.g., integral features). The main difference between AIA and full expensing is that disposals for which full expensing has been claimed are subject to an immediate balancing charge on sale based on the proceeds received; balancing charges do not apply to assets acquired using the AIA.
The structures and buildings allowance is still around, but is worth only 3% of a company's expenditure.
Mortgage interest
It is well known that mortgage interest claimable against rental income from residential lets by an individual landlord is restricted, such that only 20% basic rate relief can be claimed as a tax credit.
However, the rules do not affect individual landlords with commercial property mortgages or mortgages on properties (whether residential or not) held within a company structure. Mortgage interest can therefore achieve 100% tax relief for a commercial mortgage, whether the owner is an individual or a company.
VAT
The letting or sale of a commercial property is usually exempt from VAT, and whilst generally positive overall in reducing the cost of renting or buying a commercial property, the downside is that the landlord or buyer cannot recover the VAT on all related costs.
However, commercial landlords can exercise the ‘option to tax' and recover VAT on expenses, including building, renovating and redecorating costs. If the tenant's business is VAT-registered, there is little impact for them in the landlord 'opting'; the problem comes when the tenants cannot recover the VAT being charged. Furthermore, as the option lasts for 30 years, once exercised, VAT will have to be charged to the next tenant in the same property, even if they cannot recover (e.g. if the tenant is a charity).
Stamp duty land tax
The cost of stamp duty land tax (SDLT) (or land transaction tax in Wales, or land and buildings transaction tax in Scotland) for a commercial building is far less than that of residential property. The commercial SDLT nil-rate band threshold is currently set at £150,000; the next £100,000 at 2% with the balance over £250,000 at 5%.
However, it is important to note that on the purchase of a new commercial or mixed-use leasehold, the calculation depends on whether the purchase is of a new or replacement lease or if it is an existing lease being assigned. SDLT is payable on the lease purchase price (lease premium) and the annual rent's net present value (NPV). The NPV is based on the total rent over the life of the lease, with SDLT only being paid on the rent if the NPV is more than £150,000.
Commercial property and pensions
Commercial property in self-invested personal pension plans (SIPPs) is popular with business owners who use them to buy premises for their companies.
The advantage of investing through a SIPP is that there is no tax payable on rental income, or CGT on sale. Rent is paid by the company, which is an expense in their books; and (unlike if the individual owned the property) the SIPP pays no tax on the rental income received. The property is also not subject to inheritance tax (IHT) and ownership of the property can be passed on to a beneficiary without incurring IHT.
Practical tip
Despite the future potential for commercial lettings, residential property is more accessible to finance, has lower entry costs and has historically shown capital growth over the long term. On the downside, whilst commercial property can also show strong returns, it can be more volatile and susceptible to market changes.
