VAT on Commercial Property: Option to Tax Explained

Default position: rent from a commercial unit is exempt from VAT, so you do not charge VAT on rent and you cannot reclaim VAT on most costs like refurb and professional fees.

"This guide provides general information about UK landlord tax obligations. It is not financial or legal advice. Tax treatment depends on your individual circumstances and may change. Consider consulting a qualified accountant or solicitor for advice specific to your situation."

1. Default VAT position vs option to tax

Under VATA 1994, supplies of land and buildings (including commercial leases) are exempt, unless:

• The supply is one of the specific standard-rated types (eg freehold sale of new commercial building under 3 years old).
• You have made an option to tax (OTT) under Schedule 10.

Default (no OTT)

• No VAT on rent or most lease premiums.
• You cannot reclaim input VAT on costs linked to that exempt supply:
• Refurbishment and fit-out costs.
• Professional fees (solicitors, surveyors, agents, architects).
• Ongoing repairs and maintenance.

Opting to tax

• You choose to make your interest in specific land/building taxable at the standard rate (currently 20%).
• Result:
• You charge VAT on rent and most other taxable supplies for that property.
• You can recover input VAT on costs that relate to making those taxable supplies (subject to normal rules).

The option is made under VATA 1994 Schedule 10 Part 1 and governed in practice by HMRC VAT Notice 742A.

2. When to opt, how to notify, and how long it lasts

When it usually makes sense

You typically consider opting to tax when:

• You expect significant VAT-bearing costs (eg a GBP 50,000+ refurbishment, major professional fees) and your tenants are VAT-registered and can recover the VAT on rent.
• You are buying an opted property and want to avoid irrecoverable VAT on the purchase or future works by keeping it within the VAT system.

If your tenants are VAT-exempt (eg some financial services, health, charities), opting can be a deal-killer because they cannot reclaim the VAT you add to the rent.

How to notify

VAT Notice 742A explains:

• You decide to opt to tax a building or defined area of land.
• You notify HMRC in writing, usually using form VAT1614A, within 30 days of the decision (HMRC can accept later notifications if evidence exists).
• Your notification must clearly state:
• What land/building is being opted.
• The effective date of the option.
• HMRC no longer issue routine acknowledgement letters; the VAT1614A and your records are your evidence.

Scope:

• You can opt either land or a building; the option covers the building and its curtilage, or all buildings on opted land, including future rebuilds.

Duration:

• An option to tax normally lasts for 20 years from the effective date.

Cooling-off:

• You often have a 6-month cooling-off period where you can revoke an option if certain conditions are met and no tax advantage has been obtained. This is rarely used and has tight criteria set out in Notice 742A.

3. Disapplication, revocation, TOGC and mixed-use

When the option is disapplied

Even if you have opted, Schedule 10 disapplies the option in some cases, especially:

• Grants to connected persons who use the property for exempt purposes and where significant input VAT has been recovered (Capital Goods Scheme conditions).
• Certain supplies to relevant housing associations and for dwelling construction.

If disapplied:

• Your supply is treated as exempt, so you normally cannot charge VAT on the rent and may need to adjust prior input tax recovered under the Capital Goods Scheme.

This is the anti-avoidance "sword of Damocles" over arrangements where an OTT was used to recover large input VAT then the building is used in an exempt way.

Revoking an option

You can revoke an OTT only in limited circumstances:

• Generally after 20 years from the effective date.
• Or earlier where specific conditions are met (eg unoccupied building for certain periods or changes in use that meet criteria set in Schedule 10 and Notice 742A).

Revocation has its own notification requirements and can trigger adjustments if there were capital items.

TOGC (Transfer of a Going Concern)

When selling an opted commercial property with a sitting tenant:

• If conditions for a TOGC are met (eg buyer is VAT-registered and opts to tax from completion), the sale can be treated as outside the scope of VAT, not subject to VAT, preserving input tax history.
• If TOGC conditions are not met, the sale is normally a standard-rated supply, with VAT charged on top of the price and potential Capital Goods Scheme consequences.

TOGC status is a big deal for cashflow and for avoiding SDLT on VAT in some structures.

Mixed-use property

If a building is part residential, part commercial:

• OTT can only apply to the commercial parts.
• The residential element remains exempt; you cannot opt to tax dwellings.
• You may need to apportion input VAT between taxable (commercial) and exempt (residential) supplies.
• Some landlords ring-fence commercial units into separate leases/interests to simplify VAT treatment.

4. Worked example: GBP 200k unit + GBP 50k refurb

Assumptions:

• Purchase price for commercial unit: GBP 200,000 + VAT.
• VAT at 20% = GBP 40,000.
• Refurbishment costs: GBP 50,000 + VAT = GBP 60,000 gross, GBP 10,000 VAT.
• Landlord is VAT-registered.
• Tenant is fully VAT-registered (can recover VAT on rent).

A. No option to tax (exempt letting)

• Rental of the commercial unit is exempt.
• VAT on purchase/refurb relates to exempt supplies = no input VAT recovery.
• Result:
• You cannot reclaim the GBP 40,000 VAT on purchase or the GBP 10,000 VAT on refurbishment.
• Those amounts become part of your capital and revenue cost base (for CT and possibly CGT), but they are cash out of your pocket.

B. Option to tax in place

• You opt to tax the unit and notify HMRC with VAT1614A.
• You now charge VAT on rent (eg GBP 20,000 + VAT = GBP 24,000 a year).
• Because you are making taxable supplies, you can recover input VAT on costs linked to the property.
• Result:
• Reclaimable input VAT:
• GBP 40,000 on purchase.
• GBP 10,000 on refurb.
• Total GBP 50,000 refunded via your VAT returns.
• For a fully taxable tenant, the VAT on rent is not a problem because they claim it back. For you, GBP 50k less upfront cost is the difference between a viable and marginal project.

If your tenant were VAT-exempt, they would effectively bear the VAT in the rent, so OTT might reduce what you can charge in the market.

5. Common VAT mistakes and forum myths for commercial landlords

Mistakes

Opting without thinking about tenant profile Opting to tax when your tenants are VAT-exempt (eg many healthcare, small charities, some financial services) makes your property much less attractive, because the VAT on rent is a dead cost for them.

Failing to opt and losing huge input VAT on a refurb Doing a GBP 100k + VAT refurb on an exempt property without OTT means GBP 20k irrecoverable VAT. A lot of landlords only discover this after the invoice arrives.

Not understanding disapplication Opting, recovering large CGS-monitored VAT on a big build, then letting to a connected business using the property for exempt activities. Schedule 10 can disapply the option and force you to repay some or all of the recovered VAT.

Assuming you can freely revoke Many owners think they can "switch OTT off" when they change tenants. In practice you are locked in for 20 years except in tightly defined revocation cases.

Getting TOGC wrong Treating a sale as TOGC when conditions are not met, or failing to opt before a sale where TOGC planning could have avoided VAT. Both can lead to unexpected VAT and possible penalties.

Forum myths

"You always should opt to tax -- more VAT back is good." No: OTT is great when all current and future tenants can fully reclaim VAT. It is terrible when tenants are VAT-exempt or partly exempt, because you either must discount rents or accept voids.

"Once you opt, everything connected to that property is standard-rated forever." The option applies to your interest in the land and is subject to disapplication, TOGC treatment, and future owners' decisions. It is not a magic "always standard-rated in all circumstances" button.

"You do not need to tell HMRC as long as you charge VAT on rent." Wrong: the Option to Tax must be formally notified (usually via VAT1614A) and supported by records. Charging VAT without an OTT can put you in a bad position if HMRC later say your supplies should have been exempt and recoverability of input VAT is challenged.

If you are looking at a specific unit now, the key questions are: who are the likely tenants, how big are the VAT-bearing costs, and do you expect to sell as an investment (TOGC) within 20 years. Those three dictate whether opting is a smart move or an own goal.

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