VAT consequences of interim rental of new residential property

With the recent slowdown of the housing market, many developers are considering interim rental of new residential units, to generate revenue pending finding buyers.

In this article we explore the VAT consequences of this, and ways to mitigate the VAT cost.

Where a housing developer has constructed new houses or flats, or converted non-residential property into dwellings, and they are intended for sale, the VAT incurred on the development can be recovered in full (except some fit-out costs like appliances on which the VAT is blocked).

The VAT in question is often VAT on the land or property if incurred at purchase, and the legal and professional fees etc. This can amount to significant amounts of VAT.

For VAT purposes, interim rental represents a change of use of the property from the intended zero-rated sale, to exempt rental. Exempt use does not give a right to recovery of related input VAT. This could potentially result in clawback to HMRC of all the VAT recovered.

However, in the last slowdown in 2008 HMRC recognised this could produce an unfair outcome, and issued a VAT Information Sheet saying that where the developer retains an intention to sell the properties, there should be a fair and reasonable adjustment to reflect both the temporary exempt use and the intended sale.

This policy has been included in HMRC’s current internal guidance so should remain available to use. In most cases it should result in a smaller VAT clawback and can result in no adjustment if the amount is small enough to be below ‘De Minimis’ levels.

However, the amounts can be complex to calculate, depending on factors such as the length of the interim rental period and expected sales value, both of which may not be known or difficult to evidence.

Another option to consider is whether the new residential properties could be sold to a group company prior to the group company renting them out.

For VAT purposes this can fix the zero-rated first sale of the property by the developer, and secure the VAT recovery on its development costs, but needs to be considered alongside wider commercial, legal and tax implications including SDLT and Corporation Tax etc.

If you are considering interim rental of new residential property pending sale and would like to explore your options, please get in touch with our VAT team.