There is a special relief that allows significant tax write-offs for the cost of getting disused flats over commercial premises back into letting condition. This article will cover the basics of what could, for many property owners, prove to be a potentially valuable tax break. But be warned – there’s a limited shelf life as the government is proposing to abolish the relief from April 2013, so you have a little over a year to make use of it!
Flat Conversion Allowance (FCA)
The Flat Conversion Allowance, or FCA, was introduced in the Finance Act 2001, to encourage property owners (or leaseholders) to bring flats over shops in older premises back into use for residential letting. It was perceived that the substantial capital expenditure required in order to make them fit for a ‘modern’ tenant was acting as a real barrier to re-letting, so the FCA was drawn up to help reduce the initial costs. There are a number of criteria which need to be satisfied in order to qualify for the Allowance, but the tax relief can be worth the effort.
As with Capital Allowances generally, FCAs provide a tax deduction for eligible capital expenditure which would otherwise secure no business tax relief. However, unlike most Capital Allowances which allow only a fraction of the capital cost to be written off each period, FCAs provide an immediate 100% write-off of eligible expenditure for tax purposes. This special treatment essentially turns otherwise ‘non-deductible’ capital costs into annual expenditure, almost like repairs. If the taxpayer decides not to claim all of the 100% allowance immediately, then the balance can be claimed in later periods at a rate of up to 25% of the initial qualifying expenditure per year (again at the taxpayer’s discretion), until it is fully utilised.
Whilst it comprises part of the Capital Allowances legislation - and Capital Allowances are broadly prohibited for expenditure on residential properties – there are two unusually generous aspects to this relief which can make it particularly attractive:
1. The FCA is available for broadly all capital costs incurred and not just fixtures and similar items that qualify in the rest of the Capital Allowances code. So the cost of adding or removing walls, windows and doors would qualify, alongside ‘normal’ eligible expenditure such as plumbing or heating.
2. Most Capital Allowances provide only a cash flow benefit, because there are ‘balancing adjustments’ when an asset is sold or otherwise disposed of, and the tax relief claimed can be ‘clawed back’ by HM Revenue & Customs if the selling price is high enough. But provided the claimant ‘holds on’ to his or her interest in the building for at least 7 years from the date it is once more available for letting, then there is no claw back of FCAs and the tax relief is permanent.
What Expenditure is Eligible for FCAs?
As already mentioned, the category of expenditure is wider than usual for Capital Allowances, and it includes capital expenditure incurred on, or in connection with:
• Converting part of a qualifying building into a qualifying flat;
• Renovating a flat in a qualifying building so as to create a qualifying flat;
• Repairs incidental to the conversion or renovation of a qualifying flat; or
• Providing access to a qualifying flat.
This would include the cost of converting a single flat into a number of qualifying flats. Repairs which cannot already be deducted in calculating business profits may be included in a claim for FCAs.
As mentioned above, this goes beyond the ‘usual candidates’ for Capital Allowances such as plumbing, wiring and lighting, to include relevant changes to the fabric of the building itself. This also includes the professional costs of architects and surveyors where they relate to qualifying work on the building. Whilst it is a condition of eligibility that qualifying flats have their own access separate to the commercial part of the property, the cost of providing that separate access, such as an external staircase, is also eligible.
The capital cost of furniture is not eligible for FCAs or for extensions to the building, aside from that which may be required to provide separate access.
Expenditure may be apportioned – say for instance three floors are renovated but only two are eligible as the flat on one floor had not been unused for at least a year.
Whilst FCAs are primarily intended for flats over shops, etc., the cost of converting a basement into a flat will also qualify, if the building itself qualifies.
What are the Conditions to Satisfy for FCAs?
There are several conditions to satisfy:
1. The building’s construction must have been completed before 1 January 1980. Whilst later work on extensions started afterwards but completed by 31 December 2000 is eligible, FCAs cannot be claimed for conversion or renovation work on an extension that was itself completed after 31 December 2000.
2. The ground floor must be authorised for business use as per business ratings legislation but basically as:
• A retail shop
• Premises for the sale of food and drink
• Offices for the provision of financial and/or professional services
• Doctors’ or dentists’ surgeries or similar
• Premises for industrial processes which can be carried out in residential areas
3. The floor(s) subject to renovation, etc., must have been either unoccupied or used only for storage, for at least one year before the conversion work starts.
4. The property must not have more than 4 stories above the ground floor (Including the attic if habitable).
5. It should appear that, when the property was originally constructed, those floors above the ground floor should have been primarily for residential use.
In order to qualify the resulting flat must:
1. Not be let to a person connected with the person who incurred the relevant expenditure
2. Be suitable for letting as a dwelling
3. Be accessible without using the business premises
4. Be held for short-term letting. In this context, ‘short term’ means a term of not more than 5 years. It doesn’t need actually to be let so long as it is being actively marketed, etc.
5. Have no more than 4 rooms, ignoring kitchens and bathrooms, and ignoring any closet, cloakroom or hallway in area of 5m2 or less
6. Not be a ‘high value’ flat or have been created as part of a scheme involving the renovation or creation of ‘high value’ flats. In this context a flat basically has a ‘high value’ if, at the time the expenditure is first incurred, and assuming the work has been completed and the flat is let furnished, the notional shorthold rent would be:
No. of rooms In Gtr. Londo Elsewhere
1 or 2 rooms £350 per week £150 per week
3 rooms £425 per week £225 per week
4 rooms £480 per week £300 per week
Summary – Watch the Deadline
The Flat Conversion Allowance offers real tax incentives – provided the many criteria are satisfied. But the draft legislation published in the Chancellor’s 2011 Autumn Statement proposes to put an end to the FCA, for expenditure incurred on or after 1 April 2013 for companies, and 6 April 2013 for unincorporated businesses.
Practical Tip
Planning Points
The Flat Conversion Allowance is being withdrawn in 2013 – ostensibly for poor take-up. This could well be because of the many conditions that came as part and parcel of the relief.
On the other hand, that means there’s still well over a year to undertake work and secure some very generous tax reliefs if the circumstances fit – and there may be property investors who might still benefit from a review of previous expenditure that they now find qualifies for FCAs.
This is a sample article from the monthly Property Tax Insider magazine. Go here to get your first free issue of Property Tax Insider.
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