How Property Developers Can Get the VAT Treatment Right on Conversion Works, the First Sale or Long Lease, Options to Tax, Capital Allowances and Residential Letting

By Steve Bicknell FCMA, CGMA

Converting an office, shop, pub, warehouse or other commercial building into flats can produce some of the most valuable VAT opportunities available to property developers.

It can also produce some very expensive mistakes.

On the same development you could potentially encounter:

5% VAT

on qualifying conversion works,

0% VAT

on the first qualifying sale or long lease of the converted dwellings,

and:

20% VAT

on other costs, materials and professional services.

But there is another VAT treatment that property developers sometimes overlook:

EXEMPT

If you complete the conversion and then retain the flats for residential letting, the rental income will normally be exempt from VAT. That can restrict recovery of VAT incurred on the development.

And before you even get to the VAT on the conversion, there is another tax question worth asking when buying the commercial building:

ARE THERE CAPITAL ALLOWANCES IN THE PROPERTY?

Commercial buildings can contain qualifying fixtures and integral features, and the purchaser may need to deal with the pooling and fixed-value requirements and a Section 198 election to preserve the available allowances.

So the tax question isn’t simply:

“Is a commercial-to-residential conversion 5% VAT?”

You need to consider the entire project:

PURCHASE → CONVERSION → SALE / LEASE / RENT

Ideally, that should happen before you buy the property and before the building work starts.

HMRC’s VAT Notice 708 sets out the rules for reduced-rating qualifying residential conversions and zero-rating certain first major interests following a non-residential conversion. GOV.UK

Quick Answer – Is Commercial to Residential Conversion VAT 5%, 0% or 20%?

The answer can be:

ALL THREE

depending on exactly what is being supplied.

A typical commercial-to-residential development might involve:

The distinction between zero-rated and exempt is extremely important.

With a zero-rated taxable sale, the developer can potentially recover VAT attributable to making that taxable supply.

With exempt residential letting, VAT recovery can be restricted. HMRC confirms that input tax relating to exempt supplies is not normally deductible, whereas input tax relating to taxable supplies includes supplies that are zero-rated. GOV.UK

0% VAT AND VAT EXEMPT ARE NOT THE SAME THING.

That difference can completely change the economics of a development.

Example – Converting an Office Into Six Flats

Suppose Conversion Developments Ltd buys an old office building for:

£500,000

It then spends:

£300,000 + VAT

converting the building into six self-contained flats.

There are three possible exit strategies.

Option 1 – Sell the completed flats

If the statutory conditions are satisfied, the first grant of a major interest in each qualifying converted dwelling by the person converting can potentially be:

ZERO-RATED

That can provide a strong input VAT recovery position.

Option 2 – Grant qualifying long leases

In England, Wales and Northern Ireland, a lease exceeding 21 years can constitute a major interest for these purposes. Scotland has different rules. GOV.UK

A qualifying first grant can therefore potentially also be:

ZERO-RATED

Option 3 – Keep the flats and rent them

Residential rents are normally:

VAT EXEMPT

That can restrict recovery of VAT incurred in making those exempt supplies.

The physical conversion may be identical in all three examples.

What changes is:

THE EXIT STRATEGY.

That is why VAT needs to be considered at the beginning of a development, not after the flats have been completed.

When Is Conversion Work Eligible for 5% VAT?

The normal VAT rate for work to an existing building is:

20%

but qualifying residential conversion work can be subject to the reduced:

5% RATE.

Broadly, the reduced-rate provisions can apply to qualifying work that changes the residential use of a building, including conversion from non-residential use into dwellings and certain changes in the number of dwellings.

A straightforward example would be:

OFFICE → FLATS

or:

SHOP → DWELLING.

But the rules are broader than simply commercial-to-residential conversions.

You Can Also Get 5% When the Number of Dwellings Changes

This is an important point.

The reduced rate can potentially apply where an existing residential building is converted into a:

DIFFERENT NUMBER OF DWELLINGS.

For example:

One house → three flats

or:

Four flats → two houses

may potentially qualify.

So the 5% conversion relief isn’t restricted to buildings that were previously commercial.

What Work Can Be Charged at 5%?

Where the conditions are satisfied, qualifying services involved in the conversion can potentially be reduced-rated.

Qualifying building materials supplied by the contractor and incorporated into the building as part of those qualifying services can generally follow the VAT liability of the contractor’s work.

So if a VAT-registered contractor supplies and installs qualifying materials as part of a 5% conversion contract:

THE MATERIALS CAN ALSO BE 5%.

This can make a significant difference to development costs and cash flow.

Buying Materials Yourself Can Produce a Different VAT Result

Suppose the developer buys:

£60,000

of building materials directly from a builders’ merchant.

The merchant will generally charge:

20% VAT.

That is because the merchant is simply supplying goods.

The reduced rate potentially available to the builder arises where qualifying building materials are supplied and incorporated as part of the builder’s qualifying construction service.

So:

WHO BUYS THE MATERIALS CAN MATTER.

This becomes particularly important where the developer will not ultimately be entitled to recover all of the input VAT.

Not Everything Installed in a Building Is a “Building Material”

VAT has its own definition of building materials.

Something can physically become part of the development without necessarily qualifying as a building material for these VAT rules.

So don’t assume:

“It’s permanently fitted, therefore it’s 5%.”

The detailed nature of the item matters.

What About Architects, Surveyors and Other Professional Fees?

Professional services do not generally inherit the 5% conversion rate simply because they relate to a qualifying residential conversion.

Architects, surveyors, planning consultants, structural engineers, accountants and solicitors will generally charge:

20% VAT

where they are VAT registered and their supply is standard-rated.

Whether the developer can recover that VAT then depends on the taxable or exempt supplies to which the cost relates.

Again, the ultimate exit strategy matters.

5% on the Conversion Is Only Half the Story

For a property developer, the really interesting VAT question can be what happens when the completed property is sold.

A qualifying commercial-to-residential conversion can potentially create a:

ZERO-RATED FIRST GRANT OF A MAJOR INTEREST.

HMRC identifies the main conditions. Among other things:

• there must be a grant of a major interest;
• the building must have undergone a qualifying non-residential conversion;
• the grantor must have person converting status;
• it must be that person’s first grant of a major interest in the relevant building or part;
• the building must not be a holiday home; and
• a valid certificate must be held where one is required. GOV.UK

This is where the distinction between:

5%

and:

0%

becomes much clearer.

The 5% rate principally concerns qualifying:

CONVERSION WORK.

The 0% rate can potentially concern the developer’s:

FIRST QUALIFYING DISPOSAL.

What Is a “Major Interest”?

A sale of the freehold can constitute a major interest.

In England, Wales and Northern Ireland, a lease for a term certain exceeding 21 years can also constitute a major interest. Scotland has its own definition. GOV.UK

The point is that:

AN ORDINARY SHORT RESIDENTIAL TENANCY IS NOT THE SAME AS GRANTING A MAJOR INTEREST.

This distinction is fundamental if the developer’s VAT strategy depends on making a zero-rated supply.

What Does “Person Converting” Mean?

The zero-rating isn’t available simply because somebody owns a building that was once commercial and is now residential.

The person making the qualifying first grant needs to satisfy the statutory requirements for the:

PERSON CONVERTING.

HMRC specifically identifies person-converting status as one of the conditions for zero-rating a major-interest grant following a non-residential conversion. GOV.UK

This makes the identity of the development company important.

If one company undertakes the development but another company owns, sells or lets the completed property, the position needs to be considered before implementing the structure.

This deserves particular attention with:

GROUP COMPANIES.

What Counts as a Non-Residential Conversion?

For the zero-rating provisions, it isn’t enough simply to carry out refurbishment work.

HMRC identifies two broad situations.

The first is where a building has never previously been used as a dwelling or for a relevant residential purpose and is converted into qualifying residential accommodation.

The second is where the building has not been used as a dwelling or for a relevant residential purpose during the 10 years immediately before the relevant sale or long lease. GOV.UK

The classic examples include converting:

• offices;
• shops;
• warehouses;
• pubs;
• and other qualifying non-residential buildings

into dwellings.

But planning classification alone doesn’t necessarily determine the VAT result.

The 10-Year Rule Can Be Extremely Valuable

A building that was historically residential can potentially satisfy the non-residential conversion definition where it has not been used as a dwelling or for a relevant residential purpose during the required:

10-YEAR PERIOD.

HMRC expressly includes this second route within its definition of a non-residential conversion. GOV.UK

This can create interesting opportunities with long-empty buildings.

But don’t confuse this with another VAT rule involving empty residential property.

What If the Building Is Only Empty for Two Years?

There is a separate reduced-rate provision for qualifying renovation and alteration work on residential property that has been empty for the required period.

That can potentially give access to:

5% VAT

on qualifying works.

So there are two different concepts to keep apart:

2-year rule

Potentially relevant to the 5% reduced rate on qualifying renovation and alteration works.

10-year rule

Potentially relevant to the non-residential conversion definition and zero-rated first-major-interest provisions.

They are not interchangeable.

What If the Commercial Property Has Been Opted to Tax?

Suppose you agree to buy an office for:

£1,000,000

and the seller has opted the property to tax.

You might initially expect:

£1,000,000 + £200,000 VAT.

That creates a major cash-flow requirement.

It can also affect SDLT because VAT can form part of the chargeable consideration.

However, an option to tax does not necessarily apply where the purchaser intends to convert the property into dwellings.

VAT1614D – Disapplying the Seller’s Option to Tax

HMRC’s VAT Notice 742A contains an important provision for buildings intended for conversion into dwellings.

Where the conditions are satisfied, the purchaser gives the seller:

FORM VAT1614D

certifying the intended qualifying residential use.

HMRC confirms that the seller’s option to tax will not apply where the relevant building is not already designed or adapted as dwellings or for a relevant residential purpose and the purchaser provides the required certificate of intended use within the prescribed time. GOV.UK

This can mean the seller’s otherwise standard-rated supply becomes:

VAT EXEMPT.

For a developer acquiring an opted commercial property for residential conversion, this can be enormously important.

Example – The Potential VAT1614D Cash-Flow Difference

Suppose Conversion Developments Ltd buys an opted office building for:

£1,000,000

Without disapplication, VAT could potentially be:

£200,000.

The developer might ultimately have been able to recover that VAT depending on the circumstances.

But it first needs to:

FUND £200,000.

If VAT1614D validly causes the seller’s option to tax not to apply, that VAT charge can potentially be avoided.

There can also be an SDLT consequence because VAT can increase the chargeable consideration.

So this is something to investigate:

BEFORE EXCHANGE AND COMPLETION.

Not afterwards.

Don’t Forget Capital Allowances When Buying the Commercial Building

VAT isn’t the only tax issue to investigate before buying a commercial property for conversion.

The existing commercial building may contain valuable:

CAPITAL ALLOWANCES

within its fixtures and integral features.

Examples can include:

• electrical and lighting systems;
• heating systems;
• hot and cold water systems;
• air-conditioning and ventilation systems;
• lifts and escalators;
• external solar shading;
• fire alarms;
• CCTV;
• and other qualifying plant and machinery.

HMRC specifically identifies electrical systems, water and heating systems, air-conditioning and lifts among the integral features capable of qualifying for plant and machinery allowances. GOV.UK

This can be particularly important when buying an older:

OFFICE, HOTEL, PUB OR OTHER COMMERCIAL BUILDING

for conversion.

Ask About Capital Allowances Before Exchange

When purchasing the commercial property, ask:

HAS THE SELLER CLAIMED CAPITAL ALLOWANCES?

and:

WHAT IS HAPPENING TO THE FIXTURES?

Where a previous owner has been entitled to allowances on fixtures, the purchaser’s entitlement can depend on satisfying the statutory:

POOLING REQUIREMENT

and:

FIXED-VALUE REQUIREMENT.

HMRC confirms that, where the rules apply, the previous owner must have pooled the qualifying expenditure and the relevant fixed-value requirement must be met if the purchaser is to obtain allowances. GOV.UK

This should not simply be left until somebody prepares the first set of accounts after the purchase.

By then the commercial negotiations are over.

What Is a Section 198 Election?

A:

SECTION 198 ELECTION

under the Capital Allowances Act 2001 allows the seller and purchaser to jointly fix the amount of the sale price attributable to qualifying fixtures in the appropriate circumstances.

That amount determines:

• the seller’s disposal value; and
• the purchaser’s qualifying expenditure

for the fixtures covered by the election. GOV.UK

The fixed-value requirement generally needs to be dealt with:

WITHIN TWO YEARS OF THE TRANSFER

where it applies. HMRC confirms that the requirement can be met by formally agreeing the value within that period, commencing formal proceedings within the period or, in certain cases, through the applicable statutory statement procedure. GOV.UK

But waiting two years is hardly ideal.

CAPITAL ALLOWANCES SHOULD BE DISCUSSED AS PART OF THE PROPERTY PURCHASE.

Ideally, the position should be addressed in the:

HEADS OF TERMS AND SALE CONTRACT.

Why Does the Section 198 Election Matter?

Imagine the office building contains substantial qualifying:

• heating;
• ventilation;
• electrical installations;
• lifts;
• and other fixtures.

There may be a significant amount of qualifying expenditure attached to those assets.

If the capital allowances position is ignored when the building is acquired, the purchaser can potentially lose the ability to claim allowances that might otherwise have been available.

HMRC’s general guidance puts the practical point very simply: when buying a building from a previous business owner, the buyer needs to establish the position for integral features and fixtures and agree the relevant value with the seller where required. GOV.UK

So when buying commercial property for conversion, there are potentially two important tax documents to think about before completion:

VAT1614D

for the option-to-tax issue,

and potentially:

SECTION 198 ELECTION

for capital allowances on fixtures.

They deal with completely different taxes, but both can be much easier to resolve while the transaction is still being negotiated.

What Happens to Capital Allowances When the Building Becomes Residential?

The conversion itself makes this particularly interesting.

Capital allowances are generally restricted on plant and machinery used in a dwelling-house as part of a residential property business.

But qualifying assets in the communal areas of a block of flats can potentially still qualify. HMRC gives the example of a lift in the entrance hallway of a block of flats. GOV.UK

So changing a property from:

COMMERCIAL → RESIDENTIAL

can materially change its capital allowances position.

Some existing fixtures may also be:

• removed;
• demolished;
• replaced;
• retained;
• or incorporated into the converted development.

That means the capital allowances history should ideally be established:

BEFORE THE CONVERSION STARTS.

There may also be Structures and Buildings Allowance history associated with a commercial building, although residential use is subject to separate restrictions. That is a topic for another article rather than turning this VAT article into a complete capital allowances guide.

VAT1614D Can Create a Problem for the Seller

The purchaser may be delighted not to fund a large VAT payment.

The seller may be considerably less enthusiastic.

Why?

Because the seller may previously have recovered VAT relating to the property.

If the sale becomes exempt because the option to tax does not apply, the seller may need to consider:

• input VAT directly attributable to the sale;
• partial exemption;
• previous input VAT recovery;
• and potentially the Capital Goods Scheme.

This is one reason VAT1614D can become an important point in commercial negotiations.

HMRC confirms that supplies of land and buildings are normally exempt and that opting to tax generally changes the seller’s supply to standard-rated, usually enabling associated VAT recovery. Disapplication can therefore change the seller’s recovery position. GOV.UK

What Is the Capital Goods Scheme?

The Capital Goods Scheme, usually abbreviated to:

CGS

can require input VAT recovery on qualifying high-value capital assets to be revisited over an adjustment period.

For qualifying land and buildings, that can extend over:

10 YEARS.

This means the VAT history of the building can matter to both buyer and seller.

A developer should therefore establish early:

• has the seller opted to tax?
• when was the option made?
• was VAT recovered on acquisition?
• has substantial capital expenditure been incurred?
• is the property within the Capital Goods Scheme?
• could VAT1614D affect the seller?

These questions can influence negotiations before contracts are signed.

What If You Convert the Flats and Then Rent Them?

This is one of the biggest traps.

Suppose the developer originally planned to sell all six flats.

The development therefore anticipated:

ZERO-RATED SALES.

But the property market changes.

The developer decides:

“We’ll keep them and rent them for a few years.”

Residential rents are normally:

VAT EXEMPT.

The developer is now making exempt supplies rather than the taxable zero-rated supplies originally anticipated.

That can affect:

INPUT VAT RECOVERY.

Depending on the facts, partial exemption adjustments may be required.

Where relevant capital expenditure falls within the Capital Goods Scheme, further adjustments may also need consideration.

Zero-Rated and Exempt Are Completely Different

Suppose a developer incurs:

£100,000 INPUT VAT.

Zero-rated sale

Output VAT charged to buyer:

£0

but the sale is still:

TAXABLE.

Subject to the normal rules, VAT attributable to that taxable development activity can potentially be recovered.

Exempt residential rent

VAT charged to tenant:

£0

but the rent is:

EXEMPT.

VAT attributable to exempt activity is generally not recoverable, subject to the partial exemption rules.

Both appear to the customer to have:

£0 VAT.

But for the developer:

THE RESULTS CAN BE COMPLETELY DIFFERENT.

Partial Exemption – Selling Some Flats and Renting Others

Suppose our six-flat developer:

• sells four flats; and
• retains two for letting.

The company may now be making:

Taxable zero-rated supplies

on the four qualifying sales,

and:

Exempt supplies

from the two rented flats.

That can make the developer:

PARTIALLY EXEMPT.

Input VAT then needs to be attributed appropriately between taxable, exempt and residual/common expenditure, followed by the appropriate partial exemption calculations and annual adjustment.

This should be considered before deciding which units to retain.

What About a Separate Development Company?

This is why property developers sometimes consider separating:

DEVELOPMENT

from:

LONG-TERM PROPERTY INVESTMENT.

For example:

Conversion Developments Ltd

undertakes the development activity.

A separate:

Property Investments Ltd

holds long-term rental investments.

There can be commercial and tax reasons for separating the activities.

But simply having two companies does not automatically solve the VAT problem.

You still need to establish:

• who owns the property;
• who incurs the development costs;
• who has person-converting status;
• who makes the first major-interest grant;
• whether the companies are VAT grouped;
• whether an intra-group transaction produces the intended VAT result;
• and the SDLT and Corporation Tax consequences.

The structure needs to be designed around the actual transactions.

Your existing property-development material also highlights this tension: residential rent is exempt and can create partial-exemption problems, while separating development and investment activities can have wider tax consequences. Property_Landlord_March_Focus_G…

What About SDLT Group Relief?

Transfers between qualifying companies in the same group can potentially qualify for:

SDLT GROUP RELIEF

under Schedule 7 Finance Act 2003.

Broadly, the statutory group tests include a 75% relationship, but the detailed beneficial ownership tests also need to be satisfied.

Group relief can potentially be withdrawn if the relevant group relationship is subsequently broken within the clawback period.

So moving a completed development between group companies needs to be considered for:

VAT + SDLT + CORPORATION TAX

together.

Optimising one tax while accidentally creating a problem with another isn’t a successful structure.

Does Permitted Development Change the VAT Position?

Commercial-to-residential conversions are frequently undertaken using:

PERMITTED DEVELOPMENT RIGHTS.

But planning law and VAT law are different.

The fact that a conversion qualifies under permitted development rules does not itself determine whether:

• construction work is 5%;
• the first sale is zero-rated;
• or the seller’s option to tax is disapplied.

You still need to satisfy the VAT conditions.

Planning status can be relevant evidence, but it isn’t itself the VAT test.

Do You Need a VAT Certificate to Get 5%?

This is another common source of confusion.

NOT ALWAYS.

Certificates are required for certain supplies, particularly involving relevant residential-purpose or charitable buildings.

But ordinary dwelling conversions do not automatically require a certificate merely to obtain the reduced rate.

And a certificate does not turn otherwise non-qualifying work into:

5% OR 0% VAT.

The underlying statutory conditions still have to be satisfied.

What If the Conversion Is Sold Part-Complete?

Property developments don’t always reach completion before being sold.

A developer might sell:

• a partly converted office block;
• a development with some flats complete and others unfinished;
• a shell ready for residential fit-out;
• or an entire development midway through construction.

The VAT treatment can then become considerably more complicated.

You need to establish exactly what is being supplied at the date of sale and whether the relevant statutory conditions have been met.

This deserves its own article because:

A PART-COMPLETE CONVERSION CAN HAVE A DIFFERENT VAT RESULT FROM A COMPLETED DWELLING.

12 Tax and VAT Mistakes on Commercial-to-Residential Conversions

1. Assuming all conversion costs are 5%. They aren’t.

2. Paying contractors 20% without checking whether 5% applies. Correcting invoices later is much less satisfactory than establishing the position beforehand.

3. Buying all materials directly without considering the VAT consequences. Builders’ merchants normally charge 20%.

4. Assuming the completed residential sale is exempt. A qualifying first major-interest grant may instead be zero-rated.

5. Confusing zero-rated with exempt. They are completely different for input VAT recovery.

6. Ignoring the seller’s option to tax. Consider VAT1614D before acquiring commercial property for residential conversion.

7. Ignoring capital allowances. Establish what qualifying fixtures and integral features are already within the commercial building.

8. Failing to consider a Section 198 election. The pooling and fixed-value requirements can affect whether the purchaser obtains capital allowances on existing fixtures. GOV.UK

9. Deciding to rent after recovering VAT on the basis of intended sales. A move to exempt residential letting can affect VAT recovery.

10. Ignoring the Capital Goods Scheme. Changes in use can potentially create adjustments.

11. Putting the development into the wrong company. Person-converting status and the identity of the entity making the first major-interest grant matter.

12. Looking at tax only after the development has started.

The best time to establish the structure is:

BEFORE YOU BUY THE PROPERTY.

Commercial-to-Residential Conversion – Pre-Purchase Checklist

Before buying or converting a commercial property, establish:

What is the property’s historic use? Was it genuinely non-residential for VAT purposes?

Has it previously been residential? Could the 10-year rule be relevant?

Has the seller opted to tax? Obtain the VAT history.

Can VAT1614D apply? Consider it before exchange and completion.

Are there capital allowances within the building? Identify potentially qualifying fixtures and integral features.

Has the seller pooled the expenditure? This can be critical to the purchaser’s future entitlement.

Is a Section 198 election required? Agree the fixtures position as part of the transaction.

What will happen to the existing fixtures during conversion? Will they be retained, replaced or demolished?

What is the intended conversion? One dwelling, multiple flats, HMO or another residential use?

Will the contractors’ work qualify for 5%? Establish this before invoices are raised.

Who will buy the materials? That can affect the VAT charged.

What happens after completion? Sale, long lease or residential letting?

Who is the person converting? Particularly important in group structures.

Will there be a qualifying first grant of a major interest?

Will any units be retained? Consider partial exemption.

Is the property within the Capital Goods Scheme?

Are group transfers planned? Consider VAT, SDLT and Corporation Tax together.

Frequently Asked Questions

Is commercial-to-residential conversion work 5% VAT?

It can be. Qualifying conversion services can be subject to the 5% reduced rate where the statutory conditions are satisfied.

Is an office-to-flat conversion 5% VAT?

Potentially yes. Converting genuinely non-residential premises into qualifying dwellings is a classic example of work that may qualify.

Are building materials 5%?

Qualifying building materials supplied and incorporated by the contractor as part of qualifying reduced-rated work can generally follow the VAT treatment of that service. Materials bought separately from a builders’ merchant will normally be standard-rated.

Are architects’ and surveyors’ fees 5%?

Generally no. Professional services are normally standard-rated.

Is the sale of a converted flat VAT exempt?

Not necessarily. The first qualifying grant of a major interest following a qualifying non-residential conversion can potentially be zero-rated. HMRC’s conditions include the non-residential conversion, person-converting and first-grant requirements. GOV.UK

What is the first grant of a major interest?

Broadly, it concerns the first qualifying sale or grant of the appropriate long interest in the converted building by the qualifying person converting. The detailed conditions need checking for the particular transaction.

What happens if I keep the flats and rent them?

Ordinary residential letting is generally VAT exempt. This can restrict input VAT recovery and create partial exemption issues.

Can I disapply the seller’s option to tax?

Potentially. For a qualifying building intended for conversion into dwellings or relevant residential use, VAT1614D can cause the seller’s option to tax not to apply if the statutory conditions and timing requirements are met. GOV.UK

Are there capital allowances when buying a commercial building?

Potentially substantial ones. Commercial buildings can contain qualifying plant, fixtures and integral features such as electrical systems, heating, air-conditioning and lifts. GOV.UK

What is a Section 198 election?

A Section 198 election is a joint election between the parties that can fix the amount of the property consideration attributed to qualifying fixtures for capital allowances purposes. It fixes the seller’s disposal value and the purchaser’s qualifying expenditure for the fixtures covered by the election. GOV.UK

When should a Section 198 election be considered?

Ideally before exchange and as part of the purchase negotiations. The statutory fixed-value requirement generally has a two-year window, but leaving the issue until after completion can significantly weaken the purchaser’s commercial position. GOV.UK

Can I claim capital allowances after the property has been converted into flats?

The position changes significantly once the building is residential. Plant and machinery allowances are generally restricted for assets used in dwelling-houses in a residential property business, although qualifying assets in communal areas of multi-unit buildings can still potentially qualify. GOV.UK

Do I need a certificate for 5% VAT?

Not for every conversion. The need for a certificate depends on the nature of the building and supply.

What is the 10-year VAT rule?

A building that has not been used as a dwelling or for a relevant residential purpose during the ten years immediately before the qualifying sale or long lease can potentially fall within the non-residential conversion provisions. GOV.UK

The Most Important Question – What Will You Do With the Property?

When planning a commercial-to-residential conversion, developers naturally focus on:

purchase price, build cost, planning, development finance, GDV and profit.

But there are two further questions I would ask very early:

WHAT TAX RELIEFS EXIST IN THE COMMERCIAL BUILDING WHEN WE BUY IT?

and:

WHAT WILL WE DO WITH THE RESIDENTIAL PROPERTY WHEN THE CONVERSION IS FINISHED?

The same building could contain valuable commercial-property capital allowances when acquired, qualify for reduced-rate VAT during conversion and then produce either:

ZERO-RATED SALES

or:

EXEMPT RESIDENTIAL RENTS

when completed.

That is why these taxes shouldn’t be considered in isolation.

How Bicknell Business Advisers Can Help

At Bicknell Business Advisers, we work extensively with property investors and developers and can help with the tax and accounting implications of commercial-to-residential conversions, including:

• 5% reduced-rate conversion projects;
• zero-rated first major interests;
• VAT registration and recovery;
• VAT1614D and options to tax;
• capital allowances on commercial property acquisitions;
• Section 198 elections and fixtures;
• partial exemption;
• development versus investment structures;
• property company and group structures;
• Capital Goods Scheme issues;
• SDLT group relief;
• CIS;
• Corporation Tax;
• and the tax implications of selling versus retaining completed developments.

Commercial-to-residential conversion can offer valuable tax opportunities when the structure is right.

But the key is timing.

DON’T WAIT UNTIL THE FIRST FLAT IS SOLD TO THINK ABOUT TAX.

Ideally, establish the VAT and capital allowances position:

BEFORE THE PROPERTY IS PURCHASED, BEFORE THE BUILDING CONTRACT IS SIGNED AND BEFORE THE EXIT STRATEGY IS FIXED.

Related Reading

This article forms part of our Property Development VAT series.

Zero Rating Commercial Conversions – First Grant of a Major Interest (Residential)

Is There VAT on Part-Complete Conversions?

What Are the Practical Issues of Reduced VAT on Conversions?

Permitted Development – VAT Zero Rating

When Do You Need a Certificate for 5% VAT on Building Work?

HMO Landmark VAT Case Allowing Zero Rating

What Are the VAT Implications of Converting Commercial Buildings to Residential?

How Do You Get Zero VAT Using the 10-Year Rule?

Buildings and construction (VAT Notice 708) – GOV.UK

Opting to tax land and buildings (VAT Notice 742A) – GOV.UK

VCONST04100 – Zero-rating major interest grants after a non-residential conversion: basic conditions for zero-rating major interest grants after a non-residential conversion – HMRC internal manual – GOV.UK

CA26800 – PMA: Fixtures: Election to fix apportionment – HMRC internal manual – GOV.UK

CA26850 – PMA: Fixtures: Election procedure – HMRC internal manual – GOV.UK

Next in this series:

When Can You Use VAT1614D to Disapply an Option to Tax?

That deserves its own article because getting the VAT treatment wrong at acquisition can create a substantial funding requirement before the conversion has even started.

About the Author

Steve Bicknell FCMA, CGMA is Managing Director of Bicknell Business Advisers Limited, specialising in property taxation, landlord tax planning, SDLT, Capital Gains Tax and property company structures throughout the UK.