Option to Tax for Commercial Property Explained

As we explained in our detailed property VAT guide, commercial property is exempt from VAT with exception of new commercial building (less than three years old). The property business can choose to convert the exempt property to taxable property by opting to tax.

The main benefit of the election of "option to tax" is that the property business can reclaim the VAT costs incurred in the purchase of the property and other costs of the property business.

At the same time, if the property is opted to tax, the landlord needs to charge VAT on its rents and service charges and when selling the property. If the tenant of the property is VAT registered, charging VAT to the tenant would not be much issue for the property. However, if the tenant is not VAT registered such as small companies, charity, financial service companies etc. VAT would be additional costs to the tenant.

What is the Process of "Option to Tax"?

The process of opting a property for tax involves the following steps: 

• Making decision to opt to tax (e.g., by decision from a board meeting)
• Notifying HMRC that option has been exercised by submitting option to tax form within 30 days from the date when the decision to opt was made 
• Obtaining permission from HMRC in some special cases

Generally, the option to tax will be effective from the date decision to opt is made if HMRC is notified within 90 days. In some special cases, prior permission from HMRC is needed for 'opt to tax.' For example, specific permission from HMRC is needed if the landlord is seeking to recover VAT for past exempt supplies. 

In relation to the notification to HMRC, special rules apply if the property is acquired under 'Transfer of Going Concern (TOGC)' provisions. In case of TOGC transfers, both the decision and the notification should be made before the tax point of the transaction which is usually the date of exchange. 

Does "Option to Tax" Election for One Building Affect Other Properties?

No, unless a real estate election (once and for all election) is made. The option to tax is made on a property-by-property basis. So, the decision to opt to tax one property does not make other property taxable unless another election is made for other property as well. However, once is option is made for a property, it applies to the land as well as any building on that land.

his includes any existing building and any future building constructed on that land. If the building is demolished, the option continues to apply on the bare land. 

For landlord with large portfolio of commercial properties with intention to tax all buildings, it is better to make "real estate election (REE)". When REE is made by a company, every property in which the company has an interest will be treated as opted for tax. 

Can I Opt to Tax Before I Acquire the Property?

Yes, there is no requirement for the business to own the property for opting to tax. In fact, when you buy a commercial property which the seller has opted to tax, it is usually necessary to opt before the acquisition to enable you to recover the VAT paid on the acquisition. Option before ownership is also necessary for transactions to qualify for "Transfer of Going Concern (TOGC)" transfer. 

Can I Revoke the Option to Tax Once Made?

Following three situations where option to tax can be revoked: 

• The option can be revoked within first six months of cooling off period, provided that no supplies has been made which are affected by the option. Any input VAT claimed on the property is repayable if the option is revoked
• The option can be revoked 20 years after it was made
• The option will automatically lapse if no interest is held on the property for over six years

Can I Opt to Tax Residential Properties?

Option to tax generally has no effect on the residential properties although you can opt to tax residential properties in theory. When you let the property to residential tenants or charity, the supply is still exempt even if the building is opted for tax.  

Also, when a business sells commercial property, any option to tax can be disapplied if the buyer confirms their intention to convert the building to dwellings. 

How Does Option to Tax Affect Sub-Leases?

A landlord's option does not bind the tenant. The tenant needs to separately opt to tax if tenant sub-leases the property and would like to recover input VAT paid.

Disapplication of Option to Tax

The option to tax is disapplied where:

• The property is or will be within the Capital Goods Scheme (CGS) i.e., value is more than £250,000 (excluding VAT)
• It will be occupied by the person making the supply, by someone financing them, or by someone connected with either; and
• That occupation will be in an activity that is less than 80% taxable

Conclusion

Given the complexity of the rules and the potential for unintended VAT consequences, it is essential to take proper advice before making an election. Issues such as disapplication, TOGC treatment, and interaction with the Capital Goods Scheme can materially impact the outcome. A well-planned approach ensures that you maximise VAT recovery while avoiding costly mistakes, particularly in transactions involving connected parties or changes in property use.

Frequently Asked Questions