Is there VAT on rental income? - CloudCo Accountants

Is there VAT on rental income?

VAT rules apply for rental income: residential properties are usually VAT exempt. Some property landlords benefit from voluntary VAT registration. Commercial landlords can opt to tax and charge and reclaim VAT. All taxpayers must VAT register when their taxable turnover meets or exceeds £90,000.

The expert landlord tax team at Cloudco will be pleased to advise landlords, property investors and businesses, property developers, and all other taxpayers on the intricacies of VAT and tax planning.

Do landlords need to register for VAT?

Typically, landlords of accommodations that are residences are generally exempt from value-added tax. This means that they cannot add VAT to the rent they charge tenants, which lowers the price for tenants, but means that VAT-exempt landlords cannot reclaim VAT on supplies to do with their property. Here’s why some landlords may choose to register for VAT when eligible to do so.

If you’re considering voluntarily VAT registration, be aware that managing your VAT returns may generate some extra expenses. For starters, there are fines, penalties, and interest that apply for late returns, late payment, errors, and non-compliance. You must know the rules or hire a bookkeeper or accountant to manage your VAT, which, by the way, is a legitimate and fully tax-deductible business expense and saves you the risk of paying fines.

The other thing to remember is that when you register for VAT, you must charge your customers VAT, which will make your rental property more expensive and could deter renters. However, VAT-registered landlords can take advantage of recovering the input VAT (the VAT they paid to their suppliers).

Hence, voluntary registration can be both a disadvantage and an advantage depending on the type of property and the landlord/tax payer’s personal circumstances.

All business owners must register for VAT if they exceed or meet the £90,000 VAT threshold. Once non-VAT registered taxpayers become aware that the VAT threshold is about to be reached, they should apply as soon as possible, within 30 days. Ten to 14 days must be allowed for the registration process.

Landlords with income from commercial property rental or turnover from trade plus rental income from commercial premises that exceeds the VAT threshold must register. Residential property landlords of non-holiday accommodation with other income that is below the threshold, cannot register for VAT.

Unless you meet or exceed the threshold, you are not required to register for VAT if you are renting out a holiday home. Serviced and hotel accommodation and holiday rentals are rated as a standard rated supply at 20%. For a holiday rental business that is VAT registered, either alone or with another business, VAT must be charged at the applicable rate on all services related to running the business, and not just the rental fee.

Some tenants might be put off by the extra in VAT added to their bill, but some that are VAT registered may be able to reclaim the VAT back.

Can landlords claim VAT back?

Eligible property landlords can reduce their running costs by reclaiming input VAT (the VAT paid on supplies or services). This could outweigh the potential loss of competitiveness caused by having to add VAT to the rental fee.

For example, if you are VAT registered and let out a property solely as a holiday let, you can reclaim the VAT for the cost of building works. So, if you refit the kitchen (cost: £12,000) and add a small extension priced (cost: £18,000), on the total cost of £30,000 (+ VAT), you can reclaim £6,000 of the VAT.

VAT registration also means you can reclaim VAT on running costs and bills, including cleaning, laundry, catering, and some transport costs that are within the rules.

For VAT-registered buy-to-let (BTL) property landlords wanting to recover the VAT, the situation can be more complicated, and you should seek professional advice. For some BTL landlords that also run VAT-registered businesses making taxable supplies as self-employed individuals, there is a way to reclaim VAT on rental expenses via their VAT returns, which can mean they recover a good amount of VAT.

VAT rules on residential property

Residential property sales and purchases in the UK do not normally attract VAT, mainly to simplify the financial transaction. The rule is different for new commercial property development projects – where the development is either for the purposes of selling it or to provide serviced accommodation, which makes this a zero-rated supply for VAT purposes.

The supply should be first grant of a major interest of dwellings, relevant residential properties, or relevant charitable properties, of which the “major interest” means a freehold or lease of more than 21 years. This rule enables property businesses and developers a zero rating so that they can claim back the VAT they’ve paid to their suppliers. The construction of dwellings, student accommodation, and residential care homes generally qualify under the first grant of a major interest rule.

Since the Zero rating of supply allows developers to recover the input tax paid to their suppliers, if the developer spends 250,000 on development of the property and £15,000 of that cost was VAT, a VAT reclaim can be made from HMRC for £15,000.

For residential conversions, VAT is charged at the reduced rate of 5% on qualifying services supplied in certain circumstances. Conversion work qualifies: if a single occupancy dwelling is turned into a house of multiple occupation the reduced rate of VAT of 5% applies.

A four-bed house conversion, for example, into an HMO will qualify for the reduced VAT rate. Qualifying Services can also include those for the carrying out works to the building’s fabric such as on the walls, roof, internal surfaces, floors, stairs, windows, doors, plumbing and wiring.

VAT on residential lettings

Rental of residential accommodation – usually a simple tenancy agreement between landlord and tenant – is normally exempt from VAT. Therefore, no VAT should be added to the rental fee. This type of rental landlord is not eligible to register for VAT unless they own another VAT-registered business. This exception applies to homes in multiple occupancy (HMOs).

Likewise, assured shorthold tenancy agreement (AST) landlords fall into the “exempt supplies” category, so VAT does not apply. They are not required to register for VAT and will likely not benefit from doing so. However, if the AST property landlord has another business that is VAT registered, then VAT could be applied but is not mandatory.

For serviced accommodation, like Airbnbs and holiday apartments, the VAT rules come somewhere between residential property and hotel accommodation. These are within a taxable supply category charged at 20%, but the question of who owns the property (a business, partnership, or sole trader) determines the rule.

Holiday accommodation comes under the same rule as hotels in that they should charge VAT if they meet the VAT threshold. But as many landlords of holiday homes do not turn over the required VAT threshold amount (at £90,000 in 2024), they don’t need to add VAT to their rates.

Standard rate or option to tax

As a minimum, you should check the HMRC guidance and consider carefully whether the building is going to be used by your own business. In which case, the option to tax is unlikely to be of benefit. You should also consider if the tenant or future purchaser is likely to be VAT registered, which will enable them to recover the VAT charged but won’t add to their costs on any rental or sale.

OTT election allows property investors to charge VAT on commercial property rent or the sale of new commercial buildings, or on the sale or rental of residential developments, old commercial buildings, and so on. In this way, OTT turns a VAT-exempt supply into a taxable supply. So, this can be beneficial to avoid paying extra VAT as it allows you to recover input VAT paid that would not be possible otherwise. It makes it possible to recover VAT on related costs by turning an exempt supply, on which you cannot recover any VAT, into a taxable supply, on which you can recover associated VAT (under the normal rules).

A tax election like this will have no effect on some types of land and buildings and so there will be no benefit. Sales and lettings (i.e., land, buildings, or parts of buildings used as dwellings) used solely for relevant residential or charitable purposes, or for individuals to build their own dwellings, remain either exempt (or, in some cases, zero-rated).

The decision to elect to opt to tax involves submitting a Notice 742a to HMRC and then, once signed, charging VAT on all costs involving the property’s rental agreement.

But you will also need to seek permission from HMRC to revoke OTT. It is not an automatic right once the 20-year period has expired since HMRC will want to be certain that no anti-avoidance activity has taken place.

VAT recovery

Before you can recover VAT, you must be registered. And the VAT registration thresholds still apply to VAT-registered landlords whether they are exempt from VAT or not.

In 2024, these are:

  • Businesses with an annual VAT taxable turnover of more than £90,000 p.a. must register for VAT.
  • Businesses with an annual VAT taxable turnover of less than £90,000 p.a. can opt-in and register for VAT. This can benefit some businesses, landlords included.

The various applicable VAT rates should also be borne in mind:

  • Standard rate of VAT (20%)
  • Reduced rate (5%)
  • Zero rated.

Compliance with VAT in property transactions is essential; non-compliance can lead to losses, disputes, and real issues with HMRC.

While residential landlords’ exempt status often means they can ignore VAT, if the landlord owns another business that is VAT registered, they should take their rental income into account when completing their VAT return and include all VATable expenses in the relevant box. This is because the “partly exempt” rule applies, which means that VAT on expenses in relation to the rental property might be recoverable.

Commercial property rentals, holiday lettings, and property developments all have their own VAT rules that result in positive financial outcomes or sometimes negative ones if the rules aren’t applied correctly.

Apportioning the VAT in mixed-use properties correctly, where part of the building is used for residential purposes (which is exempt) and the part for commercial purposes (which is taxable) can become quite complicated.

Likewise, use of the Capital Goods Scheme, which allows you to reclaim VAT on an asset, should be used for adjustments to taxable supplies only in the VAT period to which it relates. You will, therefore, need to pay attention to the “intervals”, which will depend on the type of asset, whether expensive land or property, plant machinery or computer equipment.

The rules around VAT when transferring a property as a going concern (TOGC) are equally challenging. Be aware that if the TOGC conditions aren’t applied to the letter, the sale could attract VAT. This sort of error can often lead to cash flow issues created by unforeseen costs.

VAT applies to mixed used properties, and landlords of commercial-residential developments can benefit from VAT input reclaims using the option to tax rule. While this will mean they must charge VAT on the rent for the commercial part of the property, it will also mean that they can reclaim VAT on expenses incurred in relation to the commercial part of the property.

An OTT cannot apply to the residential part of the property, such as a residence above a pub, but the OTT rule can benefit landlords who want to reclaim input VAT for the area of the building that is non-residential. It should be possible to reclaim all the VAT so long as the exempt portion falls under HMRC’s de minimis limits.

Need landlord tax advice? Get in touch with Cloudco today

If you’re not working with an accountant to manage your VAT, you need to closely monitor HMRC’s changes to VAT rules and thresholds, as the annual increases in the VAT registration threshold can affect the application of VAT. Since there is no defence for ignorance in law, seeking professional tax advice is the only way to guarantee avoiding any costly mistakes.

Compliance with VAT in general and in property transactions in particular is essential, as non-abidance can lead to losses, disputes, and highly stressful situations with HMRC. Get in touch with us today.