Using pension backed mortgages to buy property

Q. I want to buy a property to lease back to my company. I need to borrow the purchase price. Is there a tax efficient way of doing this and what are the financial implications?

A. In very basic terms, if you buy a property and lease it to the company at an annual rent, you are taxed on the net rental income. You are entitled to a tax deduction for the interest on the loan taken out to buy the property but you do not get any tax relief for capital repayments of the principal amount borrowed. In the early years of a mortgage the repayments consist mostly of interest, keeping taxable rental income low. The longer you have the mortgage the more the payments become repayments of capital rather than interest and so your taxable rental income increases.

You could consider instead taking out a “pension backed mortgage”, which can be a more tax efficient way of buying property. This is effectively an interest-only mortgage, maximising the amount that can be offset against your rental income. Your company would invest separately in a pension fund which would grow to pay off the capital at the end of the term on your retirement.

Placing funds in a pension scheme is very tax efficient from your own and the company’s perspective. You are not personally taxed on contributions the company makes to your pension fund and the company gets a tax deduction for the pension contributions made.

On retirement, you can take 25 per cent of the lump sum tax free. The balance is subject to income tax. The after-tax amount is then used to repay the loan.

This has a number of advantages:

The mortgage is used to buy the property in your personal name but ultimately your company pays for it by way of pension contributions.

The payment by the company is not taxable in your hands unlike, for instance, if you had to take the mortgage repayment out of the company by way of a salary or dividends.

There is significant tax relief for both you and the company on the pension contributions.

You should keep in mind the fact that a retirement fund is to give you an income to live on into retirement so you should make sure you have other sources of income or pensions for such income requirements rather than rely on this pension, as the bulk of the proceeds will be used to repay the mortgage. In practice it is often the case that the property is sold before the pension fund is required so that the fund is still there to give you a pension if it is not required to pay off the mortgage.

Pension backed mortgages are not for everyone and every situation. However, in some circumstances they work very well and should be at least considered when making your financing decision.


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