Letting newly developed property instead of selling at a loss might seem like a good idea for housebuilders in the current economic climate. But have you considered the VAT implications?

In view of prevailing economic conditions for residential property sales, many housebuilders are looking to let new dwellings they have built or converted (from non-residential to residential), where it is not yet possible to achieve a suitable sale. But letting, as opposed to selling new/converted dwellings, results in a different VAT scenario.

Selling or granting a long lease (over 21 years) in new or certain converted dwellings is zero-rated, giving rise to full VAT recovery for the builder. However, letting residential property is VAT exempt and input VAT is not normally reclaimable on expenditure attributable to exempt business activities. Thus, short-term lettings of unsold dwellings may affect the housebuilder's ability to recover input VAT on construction and other costs. In situations like this, the builder may be required to do one or more of the following:

  • restrict input VAT recovery on current and future VAT returns

  • repay input VAT previously reclaimed on returns already submitted (a one-off clawback adjustment)

  • agree to a special method with HMRC for recovering future input VAT.

HMRC has recently published information on two possible calculation methods for the clawback adjustment. The housebuilder must calculate it as soon as temporary letting starts and must base it on a realistic expectation of the letting period or eventual sale value. HMRC may also require the housebuilder to provide evidence to support the estimates used in the calculations.

The first, preferred method calculates reclaimable input tax based on the estimated eventual sales value as a percentage of the sum of the estimated sales value, plus estimated exempt rents. The second method uses the expected period of letting as a percentage of the deemed ten-year economic life of the dwelling, but HMRC strongly discourages this calculation. It is also unlikely to provide housebuilders with a higher VAT recovery rate than the first method.

In addition to repaying VAT reclaimed on direct construction costs, receiving exempt rental income may also require businesses to restrict VAT recovery on past and future overhead expenses, particularly if there are VAT return periods where exempt rent is the only income.

However, if housebuilders plan ahead, they may be able to restructure their property ownership prior to granting a temporary letting so that a VAT clawback does not arise.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.