Why you might want to opt to tax your property
Why opt to tax a property?
If your VAT registered business always intends to use a commercial property entirely for the purposes of your own trade you can, subject to any partial exemption restrictions, recover VAT on the relevant costs without opting to tax it. If you subsequently decide to let out or sell the property you should consider whether it may be appropriate to opt to tax it in advance of the letting or sale.
The three main reasons for opting to tax are:
- To facilitate VAT recovery on ongoing revenue expenditure relating to the property, for example, VAT on the cost of a maintaining and repairing a commercial property that is let out.
- To facilitate, secure, or improve VAT recovery on capital expenditure relating to the property – this includes the VAT incurred when acquiring the property and capital expenditure on improving or refurbishing the property. In some circumstances there is a 10 year VAT recovery adjustment period and an option to tax may be appropriate to secure or improve the initial VAT recovery.
- To avoid a VAT charge on commercial property acquired in the context of a transfer of a going concern, for example acquiring a property letting business that includes commercial property that the seller has opted to tax.
In the absence of an option to tax, the rental income from the commercial properties will be exempt and the VAT recovery will only be possible if the business is de-minimis.
Let’s take an example
Andrew is registered for VAT and has purchased an old empty commercial property for £250,000 + VAT (£50,000) and found a VAT registered tenant that has agreed to pay an annual rent of £18,000 plus VAT. The seller has opted to tax the property but that option does not transfer to Andrew.
The starting point is how Andrew can recover VAT paid on the purchase of this property. The rental income received by Andrew will be exempt from VAT which restricts VAT recovery on associated costs. Therefore, Andrew will need to request an option to tax on the property before the property is transferred to Andrew. This will allow Andrew not only to recover VAT on the purchase price but also on ongoing costs like repairs, refurbishments etc.
Important points about option to tax
- A seller’s option to tax does not transfer to a purchaser and a landlord’s option to tax does not transfer to a tenant. Each party in the chain of supply should consider whether or not it is appropriate for them to opt to tax their interest in the property. For example, a tenant that is sub-letting part of a property should consider whether they should opt to tax the property.
- Where a commercial building that would otherwise be subject to VAT at the standard rate is transferred in the context of a transfer of a going concern and the purchaser opts to tax it in advance of the purchase, a VAT charge can be avoided, providing certain detailed conditions are met.
- If a business buys or sells any property which consists of ground floor shop and first floor flat or vice versa, the option to tax will be applied only on the commercial part of the building. Therefore, while selling/buying or renting, a fair apportionment of VAT will be required.
- Option to tax will make your property rental supplies expensive as you will need to charge VAT on the rent being charged to your tenants. For a small business which is not VAT registered, it will be an extra cost. Therefore, a landlord will need to be careful before applying option to tax as once it is acknowledged by HMRC, it cannot be revoked before 20 years. A VAT registered tenant will not be affected by VAT being charged on the rent, as long as they are fully taxable or de-minimis partially exempt business they can recover the VAT.