VAT on mixed-use property Value Added Tax (VAT) may be charged when buying a mixed-use property, which SDLT may also be a consideration. VAT on buying properties may be avoided using the right tax strategy. It is also possible to reclaim VAT on a mixed-use property, as well as VAT on the construction of mixed-use properties. What are the basics of VAT on the mixed-use property? As property accountants serving thousands of UK landlords that purchase buy to let properties, we know that the subject of VAT on the mixed-use property can be confusing. Many of our property investor clients ask us how to maximise the return on their portfolios. This may be achieved by utilising mixed-used property development. Mixed-use properties refer to properties intentionally used for various purposes, including commercial, residential, retail, office or parking space. For example, if you had an apartment complex with retail stores and business premises in the same area, this would be a mixed-use property investment. Commercial property investment is slightly different and includes office buildings, medical centres, hotels, retail stores, multi-family housing buildings, farmland, warehouses and garages. VAT on commercial property is a complicated area with plenty to consider. Many business owners know that the sale will be VAT exempt when they sell their business. The sale of a new commercial property (one that is three years old or less) is not a VAT-exempt sale and is subject to the standard rate of VAT. There are special rules of the building to be used by a charity or not-for-profit business. Sellers and property landlords are responsible for applying VAT where applicable. Failure to adopt the correct VAT treatment can lead to significant costs, the liability for which can fall to the seller or landlord. Both parties must obtain VAT advice on any property transactions. HMRC advises on how to work out VAT which is essential reading. Is there VAT on commercial property? The lease or sale of a commercial property is usually exempt from VAT. If so, the tenant or purchaser does not have to pay VAT. When a landlord makes an exempt supply of a property, they cannot recover the VAT on all related costs. Commercial property owners have the option to charge VAT at the standard rate of 20%. When a landlord opts to tax property, they usually need to charge VAT on all supplies that relate to the property, therefore charging all rentals or sales. Landlords can recover the VAT that has been charged about the property. If expensive refurbishments have been required, then opting to tax can be a real advantage. For some businesses, this is not appropriate to opt for tax. Many businesses cannot afford to recover VAT on the costs. These include mainly businesses in health services and charity work. This is why property investors and landlords need to consider the market sector of potential tenants or purchasers before making a decision. HMRC also needs to be notified in writing if you opt to tax. This decision is usually irreversible. How do I avoid paying VAT on a mixed-use property? If you are buying an opted commercial property, you can avoid paying VAT if you obtain TOGC (Transfer Of Going Concern) status for it by having a tenant in place and being registered for VAT, then opting to tax it at the time of the sale. The following supplies will be exempt: – all leases, assignments, surrenders, reverse surrenders or licences to occupy any interest in land or buildings – sales of freehold commercial property or civil engineering work more than three years old – sales, leases or licences of all residential or charitable property What are the pitfalls of VAT on a mixed-use property? As the rules on VAT are so complex, there are more than a few pitfalls to be aware of. Taking a commercial site and developing it for residential use is one thing, but an aim to develop a property for the combined use of commercial and residential creates extra VAT considerations. When it comes to VAT, commercial property is treated differently than residential which then affects the VAT which can be recovered on any expenditure. This also impacts the amount charged on the eventual sale of the property. It should also be noted that the VAT status of commercial space will vary depending on whether it is sold freehold, or as a long lease. The cost of constructing a new commercial building is normally liable to the standard rate of VAT. The opportunity to recoup the VAT incurred through building and construction costs will depend entirely on how the building is used, as discussed above. Many landlords have opted to tax the buildings they own, charging VAT on the rent to tenants. An option to tax means that you can claim input tax on your related property costs, including the original purchase of the building. Your tax option is overridden for any part of the building that has residential use. The rental income is still exempt from VAT. Will a Transfer Of Going Concern (TOGC) mitigate VAT? Transfer Of Going Concern (TOGC) is another consideration. When an opted to tax property is sold with the benefits of an existing lease or sold with the tenants in place, the seller is usually required to charge VAT at 20%. If the prospective owner allows the continuation of letting the property to the tenants, then subject to certain conditions, the transfer is a TOGC, and therefore no VAT is charged on the purchasing price. Special rules apply where a property is sold as part of the transfer of a business. Providing the new owner continues the business, the overall transfer is outside the scope of VAT. A commercial property may be sold with an existing tenancy in place. The sale can be a TOGC providing other conditions are met. A common area of misunderstanding is where there is a sale of trade and its premises, and the seller owned the trade and the premises in the same company but the buyers will be acquiring the property and trade in different companies. The seller used the property as trading premises but the buyer company will hold it as an investment property. These are not the same businesses so there is no TOGC. Is the sale of a new commercial property VAT exempt? The sale of new commercial property is liable to VAT at 20%. If a property is less than three years old, it is deemed new. A purchaser of a buy-to-let commercial property is much more likely to choose to opt for tax, enabling them to recoup the VAT charged on the purchase. Unless it is TOGC, once opted they will be required to charge and account for VAT on all future rents and sales of the property. If you are running a VAT registered building, you can reclaim VAT. This includes office space, industrial and retail units. You are entitled to recover VAT on costs, including property purchase, refurbishment and legal fees. In contrast, where a transaction is VAT-exempt, it means you do not charge VAT. It also means you cannot claim VAT about that transaction. How do I reduce VAT on property development? If you buy a building under commercial terms (including pubs, retail and offices) and convert the building into residential (flats and/or HMOs) then the sale of these properties is zero-rated. Sales are not zero-rated on existing residential properties which are still exempt from VAT, so if you have a company that develops property and then sells it to another company that you also own, you get a zero-rated sale and can reclaim all the VAT. New residential development is zero-rated so that you can claim back the VAT you paid to suppliers for the development work. The basic fact is that property developers must register for VAT with HMRC when their taxable turnover is more than £83,000. HMRC will often review the VAT treatment of large property transactions, and also review large claims for input tax that may be submitted by property developers. Property investors need to take advice about their VAT liability for transactions. We have written a detailed article about how to reduce VAT on property development which is worth reading.