VAT considerations if you are converting commercial property to residential

We are always emphasising the need to understand the VAT position and get the VAT treatment correct before you start any project and this month, we are reminding you that if you are converting commercial property into residential use, there are a few VAT issues to bear in mind.

You must understand the VAT treatment of a project at the outset to avoid any nasty surprises and give yourself the best opportunity to mitigate the VAT charges associated with the project.

Here we remind you of the basics and urge you to get in touch if you are planning to convert a commercial property into residential use so we can help you to structure the project in the most tax-efficient way.

What are the rules for converting commercial property to residential?

In general, when work is carried out to an existing building, VAT is charged at the standard rate of 20%, but there are some exceptions. One of these circumstances is where there is a conversion of a commercial building into a residential dwelling when a reduced rate of 5% can be applied.

So, as a very simple example, if you are converting a non-residential building such as a warehouse into dwellings at a cost of £500k, your contractor failing to apply the reduced rate could cost you an additional £75k.

When does the reduced rate apply?

The reduced rate can be applied in the following circumstances:

• Conversion of a non-residential building into dwellings;
• Conversions involving an increase in the number of dwellings within the building, for example, converting a house into flats;
• Renovating residential property which has been unoccupied for more than 2 years.

The main condition for the reduced rate to apply, is that the converted building must satisfy the criteria of being a dwelling for VAT purposes, and one of the criteria is that there mustn’t be any planning restrictions on the building which would prevent the property from being sold or used separately from any other land or building.  An example of this restriction could be a barn which could only be sold or used along with the associated farmhouse.

What does the reduced rate cover?

The 5% rate applies to costs such as:

• Work to the fabric of the buildings including walls, roofs, floors, stairs, windows, doors, wiring and plumbing;
• The provision of facilities such as water, power, heat and drainage and the installation of fitted kitchen units, sanitary-ware, central heating and light fittings;
• If the builder undertakes the work and purchases materials on the owner’s behalf, they should charge VAT at 5% on both materials and labour.

If the builder incorrectly charges VAT at the standard rather than the reduced rate, HMRC won’t refund the excess. It would be for the owner to recover the money back from the builders, so it’s important to get it right at the outset.

What does the reduced rate not apply to?

Costs for professional services such as architects and quantity surveyors, the installation of goods which are not building materials – for example, carpets or fitted bedroom furniture and costs relating to the hire of goods or scaffolding are not eligible for lower rating and chargeable to VAT at the standard rate, and will be a cost of the development.

Disposing of the Properties

There is a valuable VAT relief for the sale of dwellings which were converted from commercial property.  In many cases it is possible to adopt a structure to avail the business of the relief, allowing it to recover more VAT than would be the case if it let the converted properties itself.  There may be other tax and commercial implications of such a structure, so businesses are urged to take specific advice during the planning stages to understand what VAT mitigation strategies are available.

Get it right at the outset

Whilst it is sometimes possible to correct errors retrospectively, suppliers may be unwilling to refund VAT incorrectly charged or might no longer be in business meaning that any VAT overpaid is lost forever.

If you are planning on converting commercial property to residential, it’s imperative that the tax treatment is considered upfront so that you don’t pay too much VAT.  Get in touch if you need our help.