Residential conversions

Understanding the reduced 5% VAT rate

Converting a property can be one of the most rewarding projects in construction – whether it’s turning a disused warehouse into stylish loft apartments, splitting a large house into smaller flats, or transforming a redundant office building into a home. Beyond the architectural creativity and planning challenges, there’s also a financial incentive from HMRC that developers and homeowners may overlook: the reduced rate of 5% VAT.

The 5% VAT rate can apply to certain types of residential conversions, potentially shaving thousands of pounds off the build cost. However, the rules are detailed, and it’s important to understand precisely when this reduced rate can be applied.

What is the 5% VAT rate?

In most building projects, labour and materials supplied by VAT-registered contractors are subject to the standard VAT rate of 20%. The UK VAT system, however, recognises that certain types of construction work – particularly those that bring unused or underused buildings back into residential use – should be encouraged. To support this, HMRC allows a reduced rate of 5% VAT in specific situations, primarily involving the conversion of non-residential buildings into dwellings, or changes in the number of dwellings within an existing building.

This reduced rate applies only to qualifying building work and associated materials supplied by the contractor. It is not a blanket reduction on all costs related to the project – for example, professional fees from architects or surveyors remain VAT-able at 20%.

When does the reduced rate apply?

The 5% VAT rate could be applied in the following broad scenarios:

Conversion of a non-residential building into a dwelling

If a building was not previously used for residential purposes, converting it into a home may qualify. Common examples include:

• Converting a barn or stable into a house

• Turning an old shop, pub, or office into a flat

• Transforming a warehouse into apartments

The key is that the building must have been non-residential in its last lawful use before the conversion work started.

Conversion of a single dwelling into multiple dwellings

If a large house is split into self-contained flats, the reduced rate may apply to the building works associated with creating those additional units.

Conversion of multiple dwellings into a single dwelling

The reverse can also qualify – for example, knocking two flats together to make a single home – though there are specific conditions.

Conversions involving a change in the number of dwellings

In general, if the project changes the number of dwellings within the property, it is worth considering the application of the reduced 5% rate.

Key conditions for eligibility

While the principle sounds straightforward, HMRC applies several conditions:

1. Evidence of previous use – You must be able to prove the property’s prior lawful use. This could include planning records, council tax history, or commercial rates documentation.

2. Restrictions – Neither the separate use nor disposal of the property may be prohibited by the terms of any covenant, planning consent or similar provision.

3. Definition of “dwelling” – For VAT purposes, a dwelling is self-contained accommodation with its own access, bathroom, kitchen, and sleeping area.

4. Contractor must charge correctly – The reduced rate is applied by the VAT-registered contractor on their invoice. It is not claimed back later through a tax return like zero-rating on a new build.

5. Partial qualification – If some works qualify for 5% and others do not (for example, landscaping or building a separate garage), the contractor must split the invoice accordingly.

Common misunderstandings

• “All renovations qualify” – False
   
  General refurbishment of an existing dwelling that does not change its use or number of units is normally subject to 20% VAT, unless it meets other criteria (such as being empty for more than two years, which can also trigger the 5% rate in certain cases).
   

• “I can claim the difference back myself” – Unrelated
   
  For conversions, the reduced rate is charged directly by the contractor. If converting a non-residential building into a dwelling for you or a relative, you should take advice on the application of the DIY Housebuilders’ Scheme (which applies separately to the reduced 5% rate and may entitle you to reclaim the VAT you pay in relation to the project).
   

• “The reduced rate covers professional fees” – False
   
  Architects, structural engineers, and surveyors, for instance, must still charge VAT at the standard rate.

The empty homes angle

A related but distinct rule allows the 5% rate to apply to works on residential properties that have been empty for at least two years before the work starts. While this is not strictly a “conversion”, it is worth noting for projects where an old home is being brought back into use.

Evidence is again crucial – council tax records, utility bills, or sworn statements from neighbours can all help demonstrate the vacancy period.

Practical steps to secure the reduced rate

1. Check eligibility early – Before work begins, assess whether the property meets the qualifying conditions.

2. Document the history – Gather evidence of previous use and vacancy periods before contractors start.

3. Brief your contractor – Many builders are unfamiliar with the detailed VAT rules. Seek professional input and share HMRC guidance notes if necessary.

4. Request clear invoicing – Ensure the contractor states which works are at 5% and which are at 20%, with a clear breakdown.

Why this matters

On a £200,000 qualifying conversion project, the difference between paying 20% VAT and 5% VAT on labour and materials could be around £30,000 in savings (not taking account of the recoverability of input VAT). That’s a budget that could fund higher-quality finishes, improved insulation, or even extend the scope of the works.

In the case of Opal Carleton Limited -v- The Commissioners for HM Revenue and Customs (2010), it was held that the refurbishment of student halls of residence from bedrooms with communal kitchen facilities into studios did not meet the requirements for the 5% reduced rate to apply (namely because it was not a qualifying conversion due to its previous and continued use as a students’ hall of residence). The difference between VAT due at 5% and at what was then the standard rate of 17.5% was £669,400.

Final thoughts

The reduced 5% VAT rate for residential conversions is a valuable but often under-used relief. For property developers, it can improve profitability; for private homeowners, it can make a dream project more affordable.

The key is to establish eligibility before work starts, keep meticulous records, and ensure your contractor understands how and when to apply the reduced rate. With careful planning, you can turn a challenging conversion into a financially and architecturally rewarding success.