Letting unsold houses: VAT implications
Real Estate update November 2008

Updated November 2008

When the residential property market slows down it is common for house builders to defer their intended sales of dwellings and instead to temporarily let them out until the property market revives. Although this improves cash flow it can have an opposite effect on house builders' VAT recovery position.

The input VAT issue is caused by the fact that the first sale of a new dwelling is zero-rated, so input VAT can be fully reclaimed by the house builder on related expenses. However, the letting of dwellings is exempt from VAT, so VAT on related costs cannot be reclaimed.

Where a house builder defers its intended sales of dwellings and temporarily lets them out (even for a short period of time) it is likely to become partly exempt as the VAT incurred on the construction costs, etc. will relate to both taxable (the intended sales) and exempt (lettings) supplies. The result of this is that the following may be necessary:

• VAT recovered on past VAT returns may have to be adjusted ("clawback");
• VAT to be recovered on current and future VAT returns may have to be restricted; or
• VAT recovered on past VAT returns may have to be adjusted and VAT to be recovered on future VAT returns may have to be restricted.

Any adjustment of past input VAT is made on the VAT return relevant to when the decision was taken to rent out the property rather than sell it. In essence, when a developer lets-out premises it is operating as an investor rather than a developer and the changed VAT treatment reflects this regardless of the fact that, for most trader developers, this is merely a short-term measure in view of current market conditions.

House builders with 'de minimis' exempt input VAT related to their temporary lettings will not need to make an adjustment and can continue to recover their VAT in full. Nonetheless, to ensure mistakes are avoided, regular checks should be carried out.

Checks for 'de minimis' are carried out by applying the partial exemption method. Where a small business does not currently operate a partial exemption, a simple check can be carried out. The simple check is based on the expected time period the building will be let as a proportion of the economic life of the building (for VAT purposes this is 10 years). Input VAT is 'de minimis' if it does not exceed £625 per month on average (up to £7,500 per year) and is no more than half of the total input VAT incurred.

Points to note
House builders who are currently letting their developments temporarily (or likely to do so) should:

• confer with their tax advisers to identify opportunities for realising tax efficiencies through tax-structuring
• bear in mind that their VAT recovery may be restricted;
• carry out regular checks to confirm whether any exempt input VAT is 'de minimis';
• make the necessary clawback adjustments to past VAT returns where exempt input tax is not de minims;
• consider whether there are any alternative methods of calculating the clawback methods;
• continually review adopted partial exemption methods to ensure they are not inappropriate because of the short-term lets; and
• consider joint-venture opportunities with other housing providers (especially Housing Associations).

This publication is intended for general guidance and represents our understanding of the relevant law and practice as at November 2008. Specific advice should be sought for specific cases; we cannot be held responsible for any action (or decision not to take action) made in reliance upon the content of this publication.