The flat conversion allowance was introduced in 2001, and is intended to encourage the conversion to residential use of empty or under-used spaces above shops and other commercial premises. The scheme, which is also known as the flats over the shop (FOTS), allows the investor to claim an initial 100% capital allowances on the cost of conversion as long as the associated conditions are met. Alternatively, ‘Writing Down Allowances’ can be claimed instead.
The allowance is given in respect of `qualifying expenditure’. This is capital expenditure on the conversion of part of a qualifying building into a qualifying flat, or the renovation of a flat in a qualifying building if the flat is or will be a qualifying flat, plus any incidental expenditure on repairs.
However, the expenditure is only qualifying expenditure if the part of the building that was converted or renovated was either unused or only used for storage for at least one year immediately before the conversion or renovation work began.
Qualifying expenditure includes, for example, the costs of dividing the property to create a number of flats, the installation of bathrooms and kitchens, etc. Expenditure incurred in connection with the conversion or renovation of areas outside the direct boundary of the flat, such as the creation of stairwells, is also within the scope of the allowance.
Associated costs such as architects fees, installing or upgrading plumbing, inserting or removing windows, doors, providing access to the flats and providing external fire escapes where required, also qualify.
The cost of acquiring the land, extending the building or providing furnishings do not qualify.
To qualify for the allowance, the converted or renovated flat must be situated in a qualifying building. This is a building in respect of which the following conditions are met:
• All or most of the ground floor of the building must be authorised for business use;
• It must appear that when the building was constructed the storeys above ground level were designed primarily for residential use;
• The building must not have more than four storeys above ground level (excluding the attic unless used as, or as part of, a dwelling); and
• The building must have been built before 1 January 1980 and any extension completed on or before 31 December 2000.
The conversion or renovation work must result in a qualifying flat. This is a flat that meets the following conditions:
• It is in a qualifying building;
• It is suitable for letting as a dwelling;
• It is held for the purpose of ‘short-term’ letting;
• The flat can be accessed independently of the part of the ground floor authorised for business use;
• It does not have more than four rooms , ignoring kitchens, bathrooms and any closet, cloakroom or hallway of less than five square metres;
• It is not a ‘high value’ flat;
• It must not have been created as part of a scheme involving the creation or renovation
of one or more high value flats; and
• It must not be let to a person who is connected with the person who incurred the conversion or renovation expenditure.
One of the requirements that must be met in order for the flat to meet the definition of a qualifying flat is that it is held for the purposes of short-term letting. This is letting as a dwelling on a lease or term of less than five years.
High Value Values
The FOTS scheme is not available in respect of high value flats. For this purpose a flat is a `high value flat’ if the notional rent exceeds the limits in the table below. The `notional rent’ is the rent that could reasonably be expected to be received for the flat on the date on which the conversion or renovation expenditure is first incurred on the assumption that:
• The conversion of renovation has been completed;
• The flat is let furnished;
• The lease does not require the tenant to pay a premium or any other payments to the landlord;
• The tenant is not connected with the person incurring the expenditure; and
• The flat is let on a shorthold tenancy.
|Number of Rooms||Flats in Greater London||Flats Elsewhere|
|1 or 2||£350 per week||£150 per week|
|3||£425 per week||£225 per week|
|4||£480 per week||£300 per week|
The person incurring the conversion or renovation expenditure must have a relevant interest in the flat. This is a freehold or leasehold interest.
The Nature of the Allowance
The person incurring the qualifying expenditure can claim an initial allowance of 100% of the expenditure in the chargeable period in which the expenditure is incurred. This provides the opportunity for immediate write-off against income of the full amount of qualifying expenditure incurred in the conversion or renovation.
There is no requirement for the full initial allowance to be claimed. Where no initial allowance is claimed or a reduced allowance is claimed, a writing-down allowance is given for the unrelieved expenditure at a rate of 25% a year.
In certain situations the allowance may be clawed back. A balancing adjustment is made if there is a balancing event within seven years of the date on which the flat was first suitable for letting. Where a balancing event occurs, the proceeds from that event, as shown in the table below, must be brought into account.
Proceeds From Balancing Event
Transfer of relevant interest
Proceeds from sale if relevant interest is sold, or market value if transfer is otherwise than by way of sale.
Grant of a long lease (more than 50 years) from the relevant interest for a capital sum
The capital sum paid for the grant or, if less than the commercial premium, the commercial premium.
The coming to an end of a lease where the person entitled to the lease and any person entitled to a superior interest are connected persons
Market value of the relevant interest at the time of the event.
Death of the person who incurred the qualifying expenditure
Residue of qualifying expenditure immediately before death.
Demolition or destruction of the flat
Net amount received plus any insurance compensation.
Flat ceases to be a qualifying flat
Market value of relevant interest at time of event.
A ‘balancing charge’ arises if the proceeds exceed the unrelieved expenditure immediately before the event. This will be the case if any proceeds are received and the full 100% initial allowance was claimed.
The balancing charge is the difference between the proceeds and the unrelieved expenditure. Where there is no unrelieved expenditure (e.g. if the full 100% was claimed) the balancing charge is simply the proceeds received. The balancing charge cannot exceed the allowances (initial and WDA) given in respect of the flat.
Where there are no proceeds or the proceeds are less than the unrelieved expenditure, a ‘balancing allowance’ is given for any difference between the proceeds (if any) and the unrelieved expenditure.
Where the flat is an asset of a property rental business (which will be the case if it is let as a buy-to- let property), effect is given to the allowance as if it were an expense of that business. Any balancing charges are treated as a receipt of that business.
If looking for a property to convert or do up as a buy-to-let investment, consider empty spaces above shops or offices to take advantage of the immediate write-off of conversion or renovation costs under the `flats over the shop’ scheme.
By Sarah Bradford
This article was first printed in Property Tax Insider in July 2011.