The “option to tax” and residential conversions

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If you’re thinking of buying an old commercial property to convert to residential use, you need to read this blog.

It will explain how you can avoid (legally!) paying VAT on the property purchase.

Pub conversions are one of the most common types of conversion nowadays.  The breweries have been selling off unused properties for several years now and you can often find a decent property in the price range £100,000 – £200,000 depending on size, location and various other factors.

If you make enquiries about purchasing one of these properties, chances are that you’ll be told that the brewery has “opted to tax” the property and must charge VAT on the sale.  This means, of course, that there will be an additional 20% VAT on the selling price, which could simply be too expensive for your budget.

As I’ll explain below, you can issue a “VAT 1614” certificate to tell the vendor not to charge VAT.   But it’s important to understand main principles of the “option to tax” what is all about,  how it can apply to property purchases and how it can affect how much you pay for the property.

Commercial property and VAT

There are different VAT rules for “commercial” property and “residential property”.   The term “commercial property” isn’t defined in the VAT legislation;  we use the term to distinguish it from “residential” property, which includes certain defined types of property including dwellings, residential homes and certain properties for charitable use.

The main differences are:

  • Construction, conversions and renovations of most residential properties zero-rated or at the 5% VAT rate.
  • The construction of, or any other work done to commercial property, including buildings, land , or civil engineering works is liable to VAT at 20%.

You might assume that this doesn’t matter, because businesses can claim VAT on their costs from HMRC.  However, it’s not that simple.  If you sell or rent either commercial property or existing residential property, your income is normally exempt from VAT and this means that you can’t normally claim VAT on your costs.

This is where the “option to tax” comes into play. 

The “option to tax” allows property owners to charge VAT on commercial property sales or rentals.  This means that owner adds VAT to the sales price or rent AND can claim VAT on his costs.

That’s why you could be charged VAT if you buy an old pub or office or warehouse with the intention of converting it to residential use, whether for your family home; or to sell or rent as a business activity.

Thankfully, there is a procedure which enables purchaser of such properties to tell the vendor that they can’t charge VAT on the property sale, which does sound a bit odd!

The reason is because under EC VAT principles, members of the public should not pay VAT on the cost of their homes, whether you own or rent the property.  And even if you can claim VAT on your materials or certain construction services, such as under the self-build or DIY conversion schemes, you can NOT claim VAT on the purchase of the property.

So it’s essential that you know about this procedure and how it works so that you don’t end up with an extra 20% cost that could easily be avoided.

The VAT 1614D procedure

These are the main principles:

  • If you’re planning to use or convert the property into a dwelling or other residential or for certain charitable purposes, you can issue a VAT 1614 certificate telling the vendor that his option to tax must be “disapplied”;  which means that you can buy the property exempt from VAT.
  • The certificate must be issued to the vendor before the price is legally fixed, which is defined in the law and usually means exchange of contracts or similar.

The detailed rules are set out in HMRC VAT Notice 742a: Opting to tax land and buildings, section 3 http://tinyurl.com/qbrewhq, especially 3.4 onwards.

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The VAT 1614 procedure is, for the most part, a relatively straightforward procedure, but it does deal with a complex bit of VAT law and can seem a bit strange to those with limited VAT experience.  There are several practical issues – for example what do you do if you’re buying a property at auction, does issuing mean the certificate mean that you have to purchase the property concerned  and will the vendor increase the price if I give them the certificate?

I’ll discuss some of the most common practical issues in my next blog, but don’t hesitate to contact me if you have any queries in the meantime.

Marie

February, 2016