How does VAT work on commercial property?

VAT on commercial property in the UK can be one of the most complex areas of property taxation. Whether you’re buying, selling, renting, or developing business premises, the VAT treatment depends on the type of property, its use, and whether the owner has opted to tax.

For investors, landlords, and developers, understanding VAT rules is essential to avoid costly mistakes or missed reclaim opportunities. This article explains how VAT works on commercial property, when it applies, and how to manage it correctly in your accounts.

When VAT applies to commercial property

Unlike most goods and services in the UK, commercial property transactions are usually exempt from VAT by default. This means no VAT is charged on rent or sale, and the owner cannot recover VAT on related costs.

However, there are important exceptions. A landlord or property owner can opt to tax a commercial property, which changes the VAT treatment. Once the option is made, VAT must be charged on the rent or sale price, but the owner can reclaim VAT on associated costs such as renovations, legal fees, and management charges.

The decision to opt to tax is often strategic. It can provide cash flow benefits for owners who incur large amounts of VAT on building works or professional fees, but it also means charging VAT to tenants or buyers, which may make the property less attractive if they are not VAT registered.

Understanding the “option to tax”

The option to tax is an election made by a property owner to charge VAT on supplies of commercial property. It is made to HMRC using form VAT1614A and generally applies for at least 20 years.

Once an option to tax is in place:

• VAT must be charged on rent or the sale of the property.

• Input VAT on related costs can be reclaimed.

• The option normally applies to both the land and any buildings on it.

This option cannot be applied to purely residential properties, but it can apply to mixed-use buildings where the commercial element is clearly defined.

Landlords and developers often choose to opt to tax when they know their tenants or buyers are VAT registered businesses that can reclaim VAT themselves. This ensures they are not out of pocket for VAT incurred on costs.

Properties that are exempt from VAT

Certain commercial property transactions remain VAT exempt, meaning no VAT is charged and no input VAT can be recovered. These include:

• The sale of a commercial property that has been occupied for more than three years since completion.

• Rental income from a property where the landlord has not opted to tax.

In these cases, VAT cannot be reclaimed on related expenses such as maintenance, repairs, or legal fees. This can make exemption less attractive for landlords who regularly spend on property upkeep or professional services.

New commercial buildings and VAT

VAT treatment differs for newly constructed commercial buildings. When a new commercial property is sold or leased for the first time, it is automatically subject to VAT at the standard rate (currently 20%), even without an option to tax.

This ensures that developers can recover VAT on construction costs and other project expenses. After the first sale or letting, the property usually becomes exempt from VAT unless the owner opts to tax.

Buying commercial property and VAT

When buying a commercial property, VAT may or may not be charged depending on whether the seller has opted to tax. If VAT is charged, the buyer must pay it in addition to the purchase price.

If the buyer is VAT registered and uses the property for taxable business purposes, the VAT can usually be reclaimed through their VAT return. However, if the buyer intends to use the property for VAT-exempt activities (such as financial services or healthcare), the VAT may not be recoverable.

In some cases, the sale may qualify as a Transfer of a Going Concern (TOGC), which allows the transaction to proceed without VAT.

Transfer of a Going Concern (TOGC)

A TOGC occurs when a business, or part of a business, is sold as a going concern rather than as an isolated asset. This can apply to commercial property if the property is sold with an existing tenant and continues to operate as a rental business.

If TOGC conditions are met, the sale is not treated as a VATable supply, meaning no VAT is charged on the sale price. Both the buyer and seller must be VAT registered, and the buyer must continue to use the property for the same business activity.

TOGC treatment can provide significant cash flow benefits by avoiding VAT on large property transactions, but the conditions are strict and require careful documentation.

Leasing or renting commercial property

VAT on commercial property leases depends entirely on whether the landlord has opted to tax.

• If the landlord has not opted to tax, the rent is VAT exempt, and the landlord cannot reclaim VAT on property costs.

• If the landlord has opted to tax, VAT must be added to rent invoices at the standard rate, and the landlord can reclaim input VAT on costs such as maintenance, insurance, and management fees.

For tenants, this means rent can be 20% higher if VAT is applied. However, most VAT-registered businesses can reclaim the VAT, so it becomes a cash flow issue rather than an additional cost.

Partial exemption and VAT recovery

Some property owners or businesses are partially exempt because they make both taxable and exempt supplies. For example, a landlord may have opted to tax one building but not another. In such cases, they can only reclaim VAT on expenses related to taxable activities.

To handle this, they must perform a partial exemption calculation, which determines how much of the input VAT can be reclaimed. This can be complex and usually requires detailed record keeping and professional support.

Mixed-use properties

Mixed-use properties contain both residential and commercial elements, such as a shop with flats above. VAT treatment must be split between the two parts.

• The residential element is always VAT exempt.

• The commercial element can be subject to VAT if the owner has opted to tax.

In practice, VAT is apportioned based on floor area, rental value, or other reasonable methods. Proper documentation is important to ensure the calculation can be justified to HMRC.

Claiming VAT on commercial property expenses

If you own or manage a VAT-registered commercial property, you can usually reclaim VAT on costs related to taxable property income. Common examples include:

• Construction and renovation costs.

• Professional fees (legal, architectural, surveying).

• Repairs, maintenance, and utilities.

• Property management services.

VAT cannot be reclaimed on costs linked to exempt income, such as rent from a property where you have not opted to tax. Keeping separate records for each property helps avoid confusion and ensures accurate VAT returns.

VAT registration thresholds and timing

If your business earns more than £90,000 in taxable turnover (2025 threshold), you must register for VAT. For property businesses, taxable turnover includes rent and sales where VAT is charged due to an option to tax.

Even if you earn less than this, voluntary registration may be worthwhile if you incur significant VAT on expenses and can reclaim it. However, this only makes sense if your tenants or buyers are also VAT registered.

Accounting and record keeping for VAT

To stay compliant, property owners must maintain detailed VAT records for at least six years. These should include:

• All VAT invoices issued and received.

• Option to tax election forms and correspondence with HMRC.

• TOGC agreements, if applicable.

• Records of any exempt or partially exempt activities.

Cloud accounting platforms like Xero, QuickBooks, or Sage can help manage VAT tracking, especially for multi-property portfolios.

Professional advice and compliance

Because VAT on property is one of the most complex areas of UK tax law, professional advice is highly recommended. A property accountant or VAT specialist can help you:

• Determine whether to opt to tax.

• Assess whether a TOGC applies.

• Reclaim VAT efficiently without breaching HMRC rules.

• Manage partial exemption calculations.

• Prepare VAT returns and reconcile property transactions accurately.

Incorrect VAT treatment can lead to costly penalties or lost reclaim opportunities, so proactive planning is essential.

The bottom line

VAT on commercial property can be a valuable tool for managing tax efficiently, but it requires careful planning and precise record keeping. By understanding when VAT applies, how the option to tax works, and how to reclaim input VAT correctly, landlords, developers, and investors can structure transactions more effectively.

With professional guidance, you can avoid compliance risks, recover eligible VAT, and ensure that your property finances are managed correctly from acquisition through to sale.