A bluffer’s guide to VAT and property investment

“I never use profanity,” said Mark Twain “except in discussing house rent and taxes.” How he would have sworn, one imagines, had he ever been forced to talk about the subject of property investment and VAT. And to stop others swearing we have produced this short bluffer’s guide to the topic.

Setting the scene

As a starting point, the key facts to bear in mind are:

  • There are three different rates of VAT: a standard rate of 20%, a reduced rate of 5% and a zero rate. Some or all may apply to any given property or transaction.
  • There are different rules for residential and commercial property.
  • As far as HMRC is concerned when you sell a property you supply ‘goods’ and when you rent it out you supply ‘services’. Some supplies of ‘goods and services’ are subject to VAT, and some are not.

Do you have to register for VAT?

If your business is making annual taxable supplies of goods or services in excess of the VAT registration threshold, currently £82,000, registration is compulsory. If your turnover is less than £82,000 you may register for VAT voluntarily, which could be to your advantage if you were making zero-rated supplies.

Note the words ‘taxable supplies’. Selling or renting a residential property, for example, is not a taxable supply and so the gains/income from either doesn’t need to be taken into account.

The flat rate scheme

One thing to consider (and probably reject) is the flat rate scheme, which you can join if your annual sales do not exceed £150,000. You will still have to charge the same amount of VAT to your customers and you will still have to pay the same amount of VAT when you purchase goods or services. However, the flat rate scheme will allow you to pay a special, hopefully lesser, rate to the taxman. The downside is that you will not be able to recover VAT paid on most of your business’s purchases. Without going into the ins and outs of it, I would rarely recommend anyone in the property business to opt for the flat rate scheme. Still, if you are taking expert advice, it is worth asking about it.

The situation for residential landlords

The letting of residential property is an exempt supply for VAT purposes. This is, of course, because VAT is not chargeable on rent. For this reason, VAT cannot be recovered on expenses. On the other hand, when you are calculating your income or capital gains tax (CGT) you can include any VAT you have had to pay out.

A couple of other useful tips:

  • If you are involved in renting out holiday accommodation, your position will be different. This is, potentially, a taxable supply. Under these circumstances you may want to consider registration; although, adding VAT to your rent may make your property too expensive for tenants.
  • If you supply other services (e.g. cleaning, waste disposal or the use of some facility such as a gym), these are also potentially taxable supplies and you may want to consider whether registration is worth your while.

In either case, if your income is over £82,000 a year, you will have to register.

Residential property developers

Residential property developers are in a slightly better position. As anyone who has ever purchased a new property knows, no VAT is charged on a sale. However, HMRC classifies newly constructed residential property as being zero-rated. The benefit of this is that you can reclaim VAT on any construction costs. The same rules apply where non-residential property has been turned into residential property, and if you do any work on a listed buildings.

What about property conversions where you are altering the number of legal dwellings in a property? I am talking about, say, dividing a house into flats or turning adjoining flats or houses into a single dwelling. Here a reduced VAT rate of 5% applies to all your purchases. By the way, the reduced VAT rate of 5% is also applicable if the property you are renovating has been empty for at least 24 months before work started.

Commercial property developers

So, how about VAT and commercial property? The good news is that if you are a commercial property landlord you can actually choose whether to charge VAT on the rent. Moreover, you can make your decision on each property you own rather than having to apply it to your whole portfolio. If you decided to make a particular property VATable, you would charge VAT at the standard rate (20%) and would also be able to reclaim VAT on all the relevant purchases you made.

That’s the good news. The bad news is that having elected to charge VAT you cannot change your mind for at least 20 years. If your tenants are VAT registered then, of course, you are better off. But if your tenants are not VAT registered then it obviously adds a 20% increase to the cost of their rent. (As an aside, it is often possible to do a deal with non-VAT-registered tenants whereby they pay you a slightly higher rent in exchange for your agreeing not to register the property for VAT.)

Actually, there is more bad news when it comes to VAT and commercial property. If you decide to register a particular building for VAT, you will also have to charge it on the sale price. Moreover, you must also add VAT to the stamp duty land tax (SDLT), which can lead to a combined tax rate of nearly 25%. Although anyone who has registered for VAT (and you would almost certainly decide to be in these circumstances) can reclaim VAT incurred on the purchase of a commercial property, I don’t know of a single accountant specialising in this area who hasn’t at some point had a client who has been caught by these rules.

Property management businesses

Finally, supposing you decided to go into the property management business. Here the situation is relatively straightforward. As soon as sales go above the current £82,000 threshold, VAT must be applied. Of course, you can register voluntarily at any time regardless of turnover. You may find, though, that VAT is not always fully recoverable.