VAT on Commercial Property UK 2026: Option to Tax, Exempt Supplies and the CGS

The default position: exempt supply

Under UK VAT law (Value Added Tax Act 1994, Schedule 9, Group 1), the grant of an interest in, right over, or licence to occupy land and buildings is an exempt supply. This includes:

• Sale of a commercial building (freehold or long leasehold).
• Rental or lease of offices, shops, warehouses, factories.
• Grant of a licence to occupy commercial space.

Exempt status means:

1. No VAT is charged to the buyer or tenant.
2. The seller or landlord cannot recover input VAT incurred on costs directly attributable to that exempt supply (construction costs, professional fees, repairs, etc.).
3. Partially exempt businesses must carry out a partial exemption calculation and may be unable to recover a proportion of their general overhead VAT.

For a developer or investor who has spent hundreds of thousands of pounds on a building -- all plus 20% VAT -- an inability to recover that input tax is a significant real cost. This is where the Option to Tax becomes important.

The Option to Tax

The Option to Tax (OTT) is a statutory election under Schedule 10 of VATA 1994. Making an OTT converts the supply of a specific property from exempt to standard-rated at 20%. This applies to all taxable supplies related to that property: sale, lease, sublease, licence.

When is the OTT beneficial?

The OTT is particularly useful where:

• The owner has constructed or substantially refurbished the building (large input VAT to recover).
• The owner is renting to VAT-registered tenants who can reclaim the VAT charged on rent (so the VAT is neutral for them).
• The owner intends to sell the property to a VAT-registered buyer who will be able to reclaim the VAT.

Conversely, the OTT may be disadvantageous where tenants are unable to recover VAT -- for example, a bank, insurance company, healthcare provider or charity. These tenants bear the 20% VAT as an additional cost and may resist it in lease negotiations or insist on a rent reduction.

Making the election

To opt to tax a property:

1. Make the decision to opt (this is the date the OTT takes effect).
2. Notify HMRC within 30 days of the effective date using form VAT1614A (notification of an option to tax land and/or buildings).
3. HMRC acknowledges the notification but does not "grant" approval -- the OTT takes effect on the date elected.

An OTT can apply to a specific building or to all land within a defined area. It is important to document the election carefully, as HMRC disputes frequently arise over whether an election was properly made and notified.

The 6-month cooling-off period

Within the first 6 months of making the OTT, you can revoke it without needing HMRC permission (Form VAT1614C -- revoking an option to tax). After 6 months, revocation requires HMRC consent and is only granted in limited circumstances (e.g., the property has not been used and no input VAT has been recovered).

The 20-year rule

After 6 months, the OTT is irrevocable for 20 years from the date it was made. After 20 years, you can apply to HMRC to revoke the election (Form VAT1614J). If granted, the property returns to exempt status.

Worked example: developer with a new office block

Nexus Properties builds a new office block in Birmingham:

Without OTT:

• Nexus rents the offices. The rental is exempt -- no VAT charged to tenants.
• Nexus cannot recover the £256,000 input VAT -- it becomes a permanent cost.
• Net cost of building: £1,280,000 + £256,000 irrecoverable VAT = £1,536,000.

With OTT:

• Nexus opts to tax the property on the date construction completes.
• Notifies HMRC within 30 days.
• Charges tenants 20% VAT on rent. VAT-registered tenants reclaim the VAT -- it is cost-neutral for them.
• Nexus recovers the full £256,000 input VAT via its VAT return.
• Net cost of building: £1,280,000 -- a saving of £256,000.

The OTT adds administrative burden (VAT accounting on rent, regular VAT returns) but the financial case is compelling where input VAT is significant.

The Capital Goods Scheme (CGS)

The Capital Goods Scheme applies where a business incurs input VAT on the acquisition or construction of commercial property costing £250,000 or more (excluding VAT).

The CGS recognises that a property will be used over many years, and that the initial input VAT recovery might not reflect the eventual mix of taxable and exempt use. It requires the initial recovery to be adjusted over 10 intervals (effectively 10 years), each year reflecting the actual proportion of taxable versus exempt use.

How the adjustment works

If a commercial property costing £500,000 (plus £100,000 VAT) is opted from the outset and used 100% for taxable (opted) lettings, the full £100,000 VAT is reclaimed initially and no CGS adjustments arise.

But if in Year 4 the property begins to be used partly for exempt activities (for example, a sublease to a bank), the CGS requires an adjustment:

• The input VAT is divided into 10 equal portions (£10,000 per interval for a £100,000 initial claim).
• For each remaining interval where taxable use decreases, a repayment of VAT is required.

Conversely, if initially exempt and then opted in year 3, you can make a CGS catch-up adjustment to recover VAT for the remaining intervals.

CGS practical points

• The CGS applies from the date of acquisition or completion of construction, not from the date of OTT.
• Records must be maintained for the full 10-year period.
• A change of use -- even partial -- triggers a recalculation each year.
• On sale of the property, the CGS is not terminated -- the adjustments pass to the buyer (unless TOGC applies).

Transfer of a Going Concern (TOGC)

Where a property rental business (or part of one) is sold as a whole, the transaction may qualify as a Transfer of a Going Concern (TOGC). TOGCs fall outside the scope of VAT -- no VAT is charged on the transaction.

For a property TOGC to apply:

1. The seller must be (or was) making taxable supplies in relation to the property (usually because the property is opted).
2. The buyer must opt to tax the property before or at the time of the transfer.
3. The buyer must notify HMRC of the OTT before the transfer takes effect (or at least provide evidence that the OTT has been made).
4. The business being transferred must be a going concern -- at least one tenant in occupation (or a lease in place).

If the buyer does not preserve the OTT, the TOGC conditions fail and VAT (20% on the full purchase price) becomes chargeable. On a £2m property, that is £400,000 of VAT -- a costly mistake.

TOGC and CGS interaction

Where TOGC applies, the CGS position also transfers to the buyer. The buyer inherits the remaining CGS intervals and must continue to monitor use and make adjustments for the remainder of the 10-year period.

Commercial to residential conversion

Converting a commercial building to residential use (dwellings, student accommodation) has special VAT treatment:

• The conversion works attract the reduced 5% VAT rate (not 20%), regardless of whether the commercial building has been opted.
• An existing OTT on the commercial building does not apply to the new residential dwellings -- residential sales are zero-rated as a new build.
• The developer can recover input VAT on the conversion costs (because the eventual supply of the new dwellings is zero-rated, not exempt).

This makes residential conversion a relatively VAT-efficient activity compared with commercial development.

Partial exemption and commercial property

A business that holds both opted and non-opted properties -- or that uses commercial property partly for exempt purposes -- must undertake a partial exemption calculation at the end of each VAT period and the tax year.

The standard method apportions input VAT based on taxable turnover as a proportion of total turnover. Businesses with significant property holdings often use a special method agreed with HMRC that better reflects actual use.

Sources

• HMRC: VAT on land and property (VAT Notice 742)
• HMRC: Option to tax land and buildings (VAT Notice 742A)
• HMRC: Capital Goods Scheme (VAT Notice 706/2)
• VATA 1994, Schedule 9 Group 1; Schedule 10
• HMRC: Transfer of a Going Concern