Colin Laidlaw CTA AIIT
- VAT Tax Director - Technical Specialist
- +44 (0)330 124 1399
- Email Colin[email protected]
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Larger Homes Limited was set-up by Anne and Jon to start a property rental business. They identified that the possible yield on residential lets in areas around Stansted Airport would be significantly higher; where they looked to rent individual rooms to staff that worked at the airport compared to properties let to individual families, on a 6-month tenancy.
A business decision was therefore made to build up a portfolio of Houses of Multiple Occupancy (HMO).
Larger homes limited acquired two residential properties. One which has been a licensed HMO for the last 2 years and one detached 3-bedroom house which would be converted into a 5-bedroom HMO.
They acquired the properties for £550,000 and £300,000 respectively.
The acquisition of residential property by a company is subject to the surcharge rates. This means an additional 3% SDLT is payable on the ‘normal’ rates available to individuals.
For the property that cost more than £500,000 the higher rate SDLT of 15% will apply. However, a relief can be claimed bringing it down to the surcharge rates where the property is let out on a commercial basis.
Residential property specifically includes “residential accommodation for students, other than a hall of residence for students in further or higher education”. Whilst not all HMO’s are used as student accommodation the facilities are widely the same. It is therefore likely that in most cases, if not all, the acquisition of an HMO will be considered to be that of residential property and therefore the SDLT rates for residential property will apply.
There is no specific definition within the SDLT legislation for either halls of residence or student accommodation, however, there is a lot of guidance made available by individual district councils. In general, halls of residence are defined as accommodation that is used during term time solely by persons who are undertaking a full-time course of further or higher education. The accommodation would be for more than a certain number of persons and as a minimum should provide communal kitchens and lounges of a suitable size for the number of residents.
This is compared to an HMO which is a property where three or more people from different households live in the same property but share facilities such as the bathroom and kitchen.
It is important to note that the rules for six or more dwellings (and therefore the non-residential SDLT rates being claimed) will be unlikely to apply unless you are acquiring six individual residential properties. The mere existence of six bedrooms let to unrelated individuals will not allow the non-residential rates to apply.
An HMO’s description is evolving as the drive for different types of accommodation is increasing. What is important to consider here is whether there are sufficient facilities within the individual rooms to count as a dwelling. If you are acquiring a property which includes a diluted number of shared facilities, then it is worth reviewing the position to see if the individual rooms would be enough to constitute as individual dwellings.
From a VAT perspective the rental of dwellings on short term lets is exempt from VAT and as such there is no requirement (or entitlement) to register for VAT. Any VAT incurred by Larger Homes Limited will, therefore, be a cost.
Day to day costs will attract VAT and this cannot be recovered but fortunately no VAT is payable on the purchase of an HMO and there is scope to reduce the VAT incurred on the costs of conversion, reducing VAT on capital costs.
Most costs attract VAT at the standard rate (20%) but, on the conversion, it is possible to apply the reduced rate (currently 5%) to works which result in a change in a number of dwellings or use. This can be for example, the conversion of a house into flats or, as in this case, a house into a multi-occupancy dwelling. This would also apply to the conversion of a building currently used for a relevant residential purpose (for example a care home) or a non-residential property. Applying the reduced rate is automatic (i.e. there is no certification required) but, even though the reduced rate was introduced in 2001, it is still not commonly understood by builders and many still charge VAT at 20% so as not to fall foul of HMRC. This should be discussed with the contractors at the earliest opportunity and professional advice sought in case of difficulty. Also, not all works will qualify so, with advanced planning, it may be more cost effective to change the nature of the works to enable the reduced rate to apply.
Care should be taken on the nature of the lettings. Whilst short term residential lets are exempt from VAT, lettings which are similar to a hotel or holiday lets are subject to VAT at 20% and, subject to the level of income, may require VAT registration. HMRC would consider how the properties are held out for sale to assist them to determine whether this would apply. It is important to have clear rental agreements which set out the nature of the letting.
As the 3-bedroom house will need works to be carried out to it we need to consider the tax treatment. Any construction works will be capital for tax purposes and therefore the cost of these will be added to the original cost of the property. No immediate tax relief will be available but the cost of these works, if they still are in existence when the property is sold, will be deductible against any proceeds received.
For any decorating costs to the HMO these should be deductible against the profits of the company, assuming that the property was in a reasonable condition when it was acquired.
The tax treatment of costs relating to the replacement bathrooms and kitchens etc. will depend on the nature of the works required and the original provisions in the property on acquisition. A like for like replacement could be considered a repair and therefore deductible against profits. However, any works which are considered an improvement would be capital and added to the cost of the building itself.
Any costs associated with the purchase of either property would be capital and should be included as a cost of the asset on the company’s balance sheet.
It is unlikely that the cost of the properties themselves would get capital allowances. However, some of the furniture and moveable items should get 100% tax relief through the capital allowances regime.
The receipt of rental income will be subject to Corporation Tax. Any costs wholly and exclusively for the purpose of carrying out the rental business will be deductible. At present the rate of Corporation Tax is 19% however this is reducing to 17% from April 2020.
Where losses are derived in the initial years of the company these can be carried forward and offset against any future profits.
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