Pension savers could face a hefty penalty if they make use of permitted development rights to convert a commercial property into a residential dwelling.

Savers with a self-invested personal pension have long been able to hold commercial properties within their portfolio, but new opportunities created by planning reforms could catch out the unwary.

The government has promised the biggest shake-up of planning rules since the Second World War and among the changes it will be easier for developers to turn offices and other commercial premises into homes.

Writing for Mortgage Strategy’s sister title Money Marketing Embark Pensions product manager Andrew Phipps warns of a tax trap for anyone who owns a commercial property within their Sipp and who might be hoping to take advantage of the reforms.

He says: “The primary consideration for pension investors relates to tax. 

“In most cases, HM Revenue and Customs does not permit residential property to be held as an asset within a self-invested personal pension or a small self-administered scheme without incurring tax charges. 

“And the charges can be severe.

“Over the years we have seen examples of people making changes to properties held within their pension without first informing their provider. “Crucially, once a change is made tax penalties may be due and cannot be reversed, even if a client changes their mind.

“It’s vital members engage with their adviser and provider if they are considering any development plans on property held in their pension scheme.”

Phipps says that there are some exceptions to HMRC’s stance on not allowing residential property within a pension, but investors need to tread extremely carefully.

One such potential exemption relates to residential properties that are not yet deemed “habitable”.

However, Phipps warns that it is easy to fall foul of these rules, particularly as different pension providers interpret them slightly differently.

He says that, while a pension is not allowed to hold residential property, it can pay for the conversion of commercial property it holds into residential, provided the property is removed from the pension scheme before it becomes “habitable”.

UK providers take different views on what qualifies as “habitable”, from completion of the actual building works to the issuing of a building controls completion certificate.

Some firms insist that the property is removed from the scheme before work can even begin.

For those providers that do allow work to commence, investors must have a strategy to dispose of the property before it becomes habitable.

This can be difficult as a partially-finished property is difficult to sell on the open market, says Phipps.

If the buyer of the property is using a mortgage, many lenders will not release funds without a completion certificate.

This can leave unwitting investors in a Catch 22 situation with the pension provider unwilling to let them hold the property once it has a completion certificate, but the buyer’s mortgage lender unwilling to transfer funds without it.