VAT and flipping dwellings
One of the most common types of property developing is the practice of “flipping”; i.e. buying an existing dwelling, typically a house, renovating it and selling it. Very often these deals are done within a relatively short timescale, usually a few months. The overall profit depends on the market, but I’m told that usually the developer can expect a return of around 5% – 8%.
I’m not a property developer and certainly no expert in identifying suitable properties for flipping, conversion or any other sort of development. But speaking as a VAT specialist, I would be concerned that the 5% – 8% profit could easily be cancelled out by irrecoverable VAT on costs. And particularly so if the contractors’ services don’t qualify for the 5% reduced rate.
Here’s a simple example:
- Property cost: £250,000: VAT exempt
- Contractor’s services: £30,000: @20% VAT = £6,000
- Other materials, e.g. carpet: £2,500 @ 20% VAT = £500
- Professional fees including legal fees and agents: £4,000 @ 20% VAT = £800
Total net costs: £286,500
Total VAT: £7,300
VAT inclusive cost: £293,800
Priced for sale @ £320,000
In this example, if the developer sells the property for £320,000, then the profit would be the difference between the price and the VAT inclusive costs; i.e. £26,200; a very healthy 8.9% ROI.
Of course, if the property had been unoccupied for 2 years or longer, then the contractor’s services could have benefitted from the reduced rate of VAT. VAT at 5% on £30k costs would be £1,500, saving £4,500 on costs and increasing the ROI to 10.6%. If the margins are particularly tight, then getting the 5% VAT rate can make the difference between making a profit or losing money.
In the above situation, if prices are falling and the best price for the renovated property is say £299,500 to sell quickly, then you’re left with a very small margin of 1.94% if the contractors has to charge 20% VAT. If the 5% applied, then the ROI would be 3.5%. Not great, but marginally better than leaving the money in the building society, though not much reward for several months of your time.
When can you claim the VAT from HMRC?
I’m often asked whether, in these circumstances, the developers can claim VAT from HMRC. Well the answer is that it depends on the specific circumstances.
First, you need to understand how the basic VAT rules work:
Basic principles of VAT
- VAT is a tax on the sale (“supply”) of goods and services, such as the freeholdsale of new houses (goods) or rent from short term residential lettings (services).
- Supplies are either taxable or exempt.
- Taxable sales include sales at the standard rate: 20%, the reduced rate: 5% or the zero rate: 0%.
- Exempt sales are free from VAT.
- Businesses can claim VAT on goods and services used to make taxable
- Businesses can’t normally claim VAT on goods and services used to make exempt sales (“exempt input tax”).
The phrase “can’t normally claim VAT” is the clincher here.
Usually, businesses can’t claim “exempt input tax”; that is, the VAT on goods and/or services used to make exempt supplies. In the simple example of “flipping” a renovated property; i.e. renovating a dwelling and selling the dwelling, then the sale would be VAT exempt.
You can only claim VAT on the costs under very specific circumstances as explained below.
The first and most fundamental requirement is that the developer MUST be registered (or liable to register) for VAT. This is only possible if the developer is making TAXABLE supplies for VAT purposes. This could include other property business; such as selling new or certain converted dwellings or providing serviced accommodation. Alternatively, it could include business activities that are completely unrelated, such as running a shop, a manufacturer, providing professional services such as a solicitor or accountant.
The second requirement is that the amount of “exempt input tax” must fall within the partial exemption “de minimis” limits as explained below.
Businesses that make both taxable and exempt supplies are “partly exempt” for VAT purposes, because part of the VAT on their costs relates to their exempt supplies. Under the normal VAT partial exemption rules, the VAT on the flipping costs would be regarded as “exempt input tax” and can only be claimed IF the property developer is registered for VAT AND the exempt input tax is within the de minimis limits which are:
- £625 per month on average (i.e. up to £7,500 per VAT year) – which I call the “value” test – AND
- half of the property developer’s our total input tax in the relevant period, which is both the VAT quarter in which the VAT is incurred and the VAT year – which I call the “proportional” test.
So you have to satisfy 2 different “de minimis” tests; the value test AND the proportional test before you can claim VAT on the costs of flipping residential properties.
If your only business activity is flipping renovated dwellings, then all of your sales would be VAT exempt and you can’t register for VAT.
This means that even IF the VAT on the costs is within the numerical £625 per month de minimis limts, you can’t claim it back because it doesn’t fall within the proportional test. You only get to take advantage of the de minimis limit and claim exempt input tax if you are registered for VAT because you’re making other taxable supplies, whether it’s from zero-rated property sales/leases or other business activities.
In this article, I’ve dealt with VAT on renovated dwellings, not conversions. In certain circumstances it is possible to claim VAT on conversions from commercial to residential, as I’ve explained in my article: VAT and non-residential conversions. These rules can also apply if you sell the freehold or long lease (over 21 years) of a dwelling that has been unoccupied for 10 years or longer.
But for the most part, if you’re buying recently occupied dwellings, doing a quick refurbish and sale, then your sale are VAT exempt and you can only claim VAT on costs if you’re registered for VAT and the VAT on the property costs falls within the de minimis limits explained above.
I hope this helps to clarify the subject for those of you confused about claiming VAT on property flipping. The rules about VAT and property and whether you can claim VAT from HMRC are some of the most complex and difficult to navigate. Plus if your circumstances change from year to year, you will have to review your VAT position on a regular basis. If your only business activity is flipping houses or other dwellings, then it’s a sensible approach to assume that you can’t claim any VAT from HMRC.
If you’re in any doubt, show this article to your accountant and hopefully they can help you. Otherwise, feel free to contact me. I don’t charge for replying to an initial query in the form of an email to firstname.lastname@example.org, with a summary of the main issues, or for an initial telephone conversation.
Either way, make sure you understand how the VAT rules work so that you’re not left with an unexpected and unbudgetted VAT bill at the end of the day.