For landlords, letting property is normally an exempt activity for VAT. This means that VAT is not charged on rent and cannot be reclaimed in connection with rental properties. A landlord with no other business activities cannot register for VAT.
Landlords must bear the VAT costs of any expenses incurred, such as refurbishments, repairs, maintenance updates, and accountancy and legal fees, unless they can pass any of these costs on to the tenant.
However, the landlord of a commercial property can choose to charge VAT on rent by notifying HMRC of an option to tax thus enabling VAT incurred on expenditure to be reclaimed.
What is the 'option to tax'?
Businesses have the option to waive the VAT exemption by opting to tax the supply of certain land and buildings. The supply of land and buildings which the option to tax covers is then standard rated instead of exempt.
An option to tax can be in respect of any particular property, a landlord's portfolio of properties, or all property in a geographical location. The option applies to the land on which a building sits. If it is demolished, the option still applies to any subsequent property built on the site, unless the owner specifically excludes the new building.
How does the option to tax work?
Making an option to tax is a two-stage process:
1. A decision must be made to opt to tax the property.
2. You must notify HM Revenue & Customs within 30 days of the decision.
HMRC recommends that the notification be made on form VAT1614A. As long as you provide the required information, though, a notification can be made in any format.
It is important to note that if the lessee of an opted property subleases all or part of the property, this will be exempt from VAT, unless the lessee opts to tax. The landlord's option to tax does not affect the VAT treatment of the sub-lease.
When does an option to tax not apply?
There are certain situations where an option to tax has no effect or can be negated by the buyer:
- Where a building or part of a building is designed as a dwelling;
- Where a building or part of a building is used by a charity for its non-business activities;
- Where land is sold to an individual who intends to build a dwelling as a DIY builder;
- Where land is sold to a housing association to build dwellings; and
- Where a building is sold to a developer who intends to convert it to a dwelling.
How does option to tax apply to residential lettings?
The most common reason for when an option to tax doesn't apply is when the property is used as a dwelling. All residential letting income is exempt from VAT, and associated VAT cannot be recovered.
Can option to tax be negated by the buyer?
There are certain situations where an option to tax has no effect or can be negated by the buyer:
- Where a building or part of a building is designed as a dwelling;
- Where a building or part of a building is used by a charity for its charitable activities;
- Where land is sold to an individual who intends to build a dwelling as a DIY builder;
- Where land is sold to a housing association to build dwellings; and
- Where a building is sold to a developer who intends to convert it to a dwelling.
Residential letting exemption
Perhaps the most important and common of these is where the property is to be used as a dwelling. All residential letting income is exempt and no associated VAT can be recovered.
Option to tax and the sale of commercial property
The sale of commercial property is exempt if the owner has not opted to tax, and standard-rated if there is an option to tax in place.
If the buyer intends to use the property(s) as a dwelling, or several dwellings, or for solely residential purposes, they can request not to apply the option to tax. The sale will revert to being exempt.
This can apply where the building, or relevant part, is intended for such use without conversion work being undertaken, or after conversion.
What if only part of a building will be used for dwelling or residential purposes?
If only part of the building is intended for use as a dwelling or solely for a relevant residential purposes, the option to tax will apply to the part of the building not intended for the qualifying use. The value of the supply must be fairly apportioned between the exempt and taxable elements.
The sale will only be exempt from VAT if the buyer provides the seller with a certificate (form VAT1614D) before the price is legally fixed, such as through the exchange of contracts, letters, or the signing of heads of agreement.
How does option to tax work if I want to use part of a building for charitable purposes?
The sale of an opted property to a charity which intends to use the property for a non-business purpose is exempt from VAT. There’s no requirement for a formal certificate to be given, but written confirmation of the intended use must be obtained from the charity.
In cases where only a part of a building is intended to be used for a charitable purpose (other than as an office), the option to tax the part used for the charitable purpose will not apply, so long as the different functions are carried out in clearly defined areas. The value of the supply should be apportioned between the exempt and taxable elements.
Transfer of a going concern (TOGC) essentials
VAT may not need to be charged on the sale of an opted property under certain conditions. These circumstances include when the property is rented to a tenant and the benefit of the lease is being transferred to a new owner. This makes it a transfer of going concern instead of a transfer of assets.
VAT on property is complex, and advice should be sought before every transaction.
Need more information on the option to tax?
VAT remains one of the least understood taxes, which is why Shorts has a specialist VAT advisory team. Our team can help guide businesses through the complex maze of VAT legislation.
The team can also help with all areas of VAT, including basic issues such as initial registration, the completion and submission of VAT returns and advice on correcting errors and mistakes. It also covers complex issues such as assessments, control visits, cross-border transactions, the option to tax, and DIY house builds.
You can also learn more about Land and Property VAT on our dedicated service page.
Lynne Gill
My area of expertise is land and property transactions but I have extensive knowledge of both domestic and international VAT and I love complex VAT queries. I have an Honours degree in Business Studies and a VAT legal and technical qualification from the Institute of Indirect Taxation.
View my articlesTags: Land & Property, VAT, Business Taxes, option to tax
