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A viable pension option
The property values in some parts of the local market appear to have finally got back to an upward trend. Although current prices are still significantly behind levels seen in 2006/2007 there has been considerable growth in some parts of the country. The largest area of growth is in Dublin. According to CSO figures for 2013 residential property prices in the Dublin region increased by circa 15.7% in 2013 compared to 2012. However, property prices are still 49.1% below their highest level in February 2007.
Property investment incentives
There have been a number of initiatives introduced by the Government to try and stimulate investment in the property market. One of the most significant initiatives is the introduction of the Real Estate Investment Trust (“REIT”). A REIT is a tax efficient property investment structure. There are a significant number of requirements to be met to establish a REIT. Of key significance is the fact that a REIT must be a listed company with its shares listed on the Irish or another EU stock exchange. Given the costs associated with establishing a REIT, public listing on a stock exchange and the ongoing administrative costs it is not a mechanism that small to medium sized investors would seek to establish themselves.
Apart from the REIT other measures introduced to stimulate the property market are the reduced stamp duty rates, and the capital gains tax relief on properties acquired before 31 December 2014. Currently the stamp duty on residential property is 1% - 2%, and stamp duty on non-residential property is 2%.
Where a property is acquired between 07 December 2011 and 31 December 2014 and held for at least 7 years, any gains arising on that property in the 7 years after acquisition are exempt from CGT. This relief is of course subject to certain restrictions.
Current market return on property investments
When investing in any asset one looks to the yield one can get on the investment. From a pension point of view many individuals look to find an investment that will provide a steady stream of income for a prolonged period. For many people property is seen as such an investment.
According to the 2013 “Daft.ie Rental Report” gross property yields on average across Ireland are 6%. In Dublin the yields range from 5.2% in South County Dublin to 8.1% in Dublin City Centre. Rent levels continue to grow year on year. Access to property is still quite difficult due to lack of property supply in desirable areas and a lack of access to finance. Of course it is impossible to predict how the market will fare in the coming years and so, as with any investment there is a risk of the yield on investment reducing.
Using your pension to buy property
Individuals considering whether to invest in the property market might consider using their pension funds to purchase property. One of the main benefits of using a pension fund to purchase property is that you can use monies which have not been subject to income tax to purchase the property. Property purchased outside a pension fund is purchased from post income tax proceeds, or else purchased using borrowings that must be repaid using post tax income.
Given the current marginal rates of tax, up to a maximum of 55%, it is clear that significant savings can be made by using your pension fund to invest in property rather than investing through after tax income. Of course not all individuals have control of where their pensions are invested, but those who have an element of input into pension investments might consider the opportunities currently available in the property market. In addition those who currently hold an Approved Retirement Fund (“ARF”) might consider having the fund purchase property.
The question of what type of property you are looking to invest in largely depends on whether the property is going to be a long term investment which will be used to generate a steady stream of income, or if you are looking to hold the property for a fixed period, generating income while it is held but which you will ultimately try to sell on at a gain. This is something that should be considered carefully prior to any investment.
Restrictions on property investments through a pension fund
The use of a pension fund to purchase property is of course subject to certain restrictions. In particular there are a number of restrictions in place with regard to investments by Small Self-Administered Schemes (“SSAS”). An SSAS is a pension scheme with 12 or fewer members (although in some cases the scheme can have more than 12 members). The restrictions are in place to ensure that the fund is established for the purpose of providing relevant benefits (these are benefits such as pensions, lump sums, gratuities or other such benefits given on retirement or death). The holders of such funds generally have more input into the type of assets their pensions are invested in compared to those who are members of occupational pension schemes or who hold a Personal Retirement Savings Account (“PRSA”) through pension providers. PRSAs are generally held by those who are not part of an occupational pension scheme.
It is possible for single member pension schemes to borrow in order to acquire an investment property. However, there are certain restrictions on such borrowings. For example the loan cannot be an interest only loan, and it must not last for a period of more than 15 years. In the current banking environment loans to pension funds are not easily available.
A key issue, when investing in property through a pension fund, is to avoid any use of the property being considered as a personal benefit to the fund holder, or a connected party, as this may be considered a taxable distribution. Therefore to avoid an unexpected income tax liability individuals need to monitor how the property in their pensions is being used.
In terms of restrictions, by way of example, the following property investments by an SSAS are prohibited:
- Acquisition of property with a view to disposing of, or letting the property to the employer entity, its directors and associated companies.
- Property acquired to be developed and sold on.
In addition, the investment should not result in a direct benefit for the fund holder or his family, for example the pension fund cannot purchase the property from the fund holder, or the fund holder should not occupy the property or derive any use or benefit from the property following its acquisition by the pension fund.
Property and ARFs
For an individual who has retired and holds an ARF the following property-related events will be considered a distribution subject to income tax:
- Acquisition of property from the beneficial owner of the ARF or connected person,
- Sale of an ARF asset (such as an investment property) to the beneficial owner or connected person,
- Acquisition of residential or holiday property for use by the beneficial owner or connected person,
- Acquisition of property which is to be used in connection with any business of the beneficial owner, or of a connected person.
In order to avoid an unexpected income tax liability the use of property purchased through an ARF should be monitored carefully.
To invest or not to invest
It is important to maintain the boundaries with respect to property investments through a pension fund so as to maintain the significant tax benefits of holding property through your pension, and generate a steady stream of tax exempt income in the pension which can be accessed in the future by the fund holder. Investing now at the current price levels, together with use of pre income tax funds held in a pension might be an attractive investment for many pension funds.
If the restrictions in place on property investment through pensions cannot be met then it may still be a good time for a cash buyer to invest given the relatively low prices, the current healthy yield on residential property, in particular in Dublin, the low stamp duty rates and the potential for CGT relief (if the property is acquired before the end of 2014).
Whatever investment option is chosen it is clear that certain property values are on the increase. As a long term investment to generate a steady stream of income or as a medium term investment to be sold on, it appears there are opportunities to be had at present in Irish property. Proper advice should however be taken before any decisions are made and any property investment should only be considered as part on an investment strategy designed to achieve a well-diversified overall investment portfolio.