Letting land and buildings is exempt — Schedule 9, Group 1 of the VAT Act 1994. An option to tax under Schedule 10 turns that property's supplies standard-rated at 20%, which is how a landlord recovers VAT on refurbishment and fees. Notify HMRC within 30 days of the decision. Then you are committed: out within six months under the cooling off rules, automatically after six years holding no interest, or otherwise not for twenty years.
Not sure whether a property is opted, or whether it should be? Send me the property, who the tenants are and what you have spent on it, and I will tell you whether opting gains or loses you money - and whether the option you think you have was ever actually notified. Free, back to you within one working day, and nothing follows unless you ask for it.
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The default: exempt
Group 1 of Schedule 9 exempts the grant of any interest in or right over land, which covers an ordinary commercial lease, a licence to occupy, and the sale of an existing building. So rent arrives with no VAT on it and the landlord recovers no input tax on the costs of owning the thing.
That second half is the problem the option exists to solve. An exempt landlord who spends £100,000 refurbishing a unit absorbs the VAT on it. There is nothing to reclaim, because there are no taxable supplies for it to attach to.
What the option actually does
An option to tax is an election under Schedule 10 to make your supplies of a particular property standard-rated instead of exempt. Three features of it surprise people.
- It belongs to the person, not the building. Your option binds your supplies of that property. It does not travel with the property to a buyer, who must make their own decision. Two units in the same terrace, same owner, can carry different treatments.
- The decision and the notification are separate. You decide, then you tell HMRC — normally within 30 days, under paragraph 4.2.1 of VAT Notice 742A. HMRC may accept a late notification where you can show the decision was genuinely taken at the time, which is exactly why a dated board minute is worth writing.
- An unnotified option is not effective. If VAT has been charged on rent for years on the strength of an option nobody ever notified, that VAT was charged without authority — and the tenant's recovery of it is equally exposed.
The commonest finding on a property VAT review is not a wrong rate. It is a missing piece of paper. Options made decades ago, by predecessors, on properties since reorganised between group companies. If you cannot put your hand on the notification and HMRC's acknowledgement, you do not know what the position is — and neither will a buyer's solicitor on the sale.
What the option cannot touch
Section 3 of the notice disapplies an option for three main categories:
| Category | What it covers | How it is triggered |
|---|
| Dwellings (3.2) | Buildings designed or adapted and intended for use as a dwelling — a house, a block of flats | By the nature of the building |
| Relevant residential (3.3) | Care homes, student accommodation and similar, used solely for that purpose | The buyer or tenant must tell you before the supply |
| Relevant charitable (3.5) | Buildings used solely for a relevant charitable purpose, other than as an office for general administration | The buyer or tenant must tell you before the supply |
The timing on the last two is the part that bites. The certificate has to reach you before the supply is made. A tenant who produces it afterwards has not disapplied anything, and a landlord who accepts a late certificate and credits the VAT has given away money that was properly due.
The three ways out
- Six-month cooling off. Revoke within the cooling off period and, under paragraph 4.5, the option is treated as never having had effect at all. Conditions apply and they are set out in section 8.
- Automatic, after six years. Paragraph 8.2.1: the option is automatically revoked where you have held no interest in the opted land or building for a continuous period of six years, beginning at any time after the option took effect. No notification is needed. There are exclusions, principally where a sale carried overage terms, and several that apply only within VAT groups.
- After twenty years. Paragraph 6.2: an option cannot normally be revoked until at least 20 years have passed.
Between six months and twenty years there is, for a landlord who still holds the property, essentially no exit. That is the weight of the decision, and it is routinely made by ticking a box on a form because an accountant mentioned recovering VAT on a refurbishment.
A worked example: when opting gains, and when it costs
A single commercial unit. Refurbishment costs £120,000 + VAT of £24,000. Rent thereafter £30,000 a year.
- Not opted. The £24,000 of VAT is irrecoverable and becomes part of the cost of the building. Rent is £30,000, exempt.
- Opted. The £24,000 is recovered in full. Rent becomes £30,000 plus £6,000 of VAT a year.
If the tenant is an ordinary VAT-registered trading company, the £6,000 costs them nothing — they recover it — and the landlord is £24,000 better off. That is the case for opting, and it is a good one.
Now change the tenant. A dental practice, an optician, an insurance broker, a care provider, a small charity: all of them make exempt supplies and recover little or no input tax. To that tenant your £6,000 of VAT is not a timing difference, it is a 20% rent increase. It will be argued at the rent review, it will be reflected in what they are prepared to pay, and over a twenty-year commitment it may well cost you more than the £24,000 you recovered. Opting is a decision about your tenant's VAT position at least as much as your own.
Service charges, insurance and other recharges
A service charge to the occupier of commercial premises is normally part of the consideration for the letting and follows the liability of the rent — exempt if unopted, standard-rated if opted.
The same is true of recharged buildings insurance, and that is where landlords most often go wrong, because the premium itself was exempt so the recharge looks as though it should be too. It is not: the policy is the landlord's own, and the recharge follows the main supply. The full reasoning, and the arithmetic of getting it wrong, is set out in VAT on insurance.
References above are to the VAT Act 1994 and HMRC's VAT Notice 742A, linked in full. This page is a general reference and not advice on a particular property — an option to tax is a twenty-year decision and worth taking properly. If your own position does not match what is set out here, that is exactly the sort of thing worth sending over.