Jennifer Adams considers the tax implications of demolishing a residential property and rebuilding from scratch rather than just renovating.
Every building has a life span - usually between 80 and 100 years. Older buildings require a considerable amount of maintenance, and there comes a point when repairs are not always cost-effective.
Sometimes, the most practical option is to demolish and start anew. As always with property, there are tax considerations to take into account.
‘Deemed disposal’
Under land law, demolishing a building (accidentally or deliberately) is not a disposal, as the land on which the building stands remains. However, under tax law the disposal is subject to the capital gains tax (CGT) legislation and creates a 'deemed disposal' separate from the land. The legislation relevant to such an action is in TCGA 1992, s 24(1), which states that a deemed disposal is created ‘on the occasion of the entire loss, destruction, dissipation or extinction of an asset’.
A claim under this section treats the property as being 'deemed' to be sold and immediately reacquired for consideration equal to the market value of the whole site when the house is demolished. Such a claim allows the cost of the building (as distinct from the land) to create a loss for CGT purposes. This loss can be deducted from any other capital gains made in the same tax year or future tax years.
There are some conditions to consider when making a claim, not least that HMRC will expect to see the entire destruction of the building such that only the foundations remain. Even if one wall remains, the building will not be 'entirely' destroyed, and no claim will be allowed. However, making a claim is a choice that need not be made if it is more tax-efficient not to. If this is the case, there will be no disposal (so no loss), with any demolition costs being added as enhancement expenditure deductible from any gain on the future sale of the house (see HMRC’s Capital Gains Manual at CG15200).
A claim under TCGA 1992, s 24 relates only to the loss on the destruction of the building – the land remains. Therefore, a separate CGT calculation will be required to ascertain the gain (or loss) that would have arisen should the land have been sold (with no building on it) at the current market value. Sometimes, the market value of the land will be worth more than the original house's total acquisition costs (e.g., possibly, the land has acquired valuable planning permission since the property was purchased). Another possible scenario is that the value of the land has increased, producing a gain greater than the loss claimed for the building. In such a situation, a section s 24 claim would not be tax-efficient.
Interaction with principal private residence relief
On some occasions, a purchaser will buy a dilapidated property, demolish it, and replace it with a more modern one, intending to make it their main residence and claim principal private residence (PPR) relief on the eventual sale.
PPR relief is a CGT relief, and where the owner builds their own home the point at which the PPR relief starts could be unclear. For example, the owner may already own the land on which the house is to be built or may buy a plot specifically for the purpose. In this situation, there will be no property in which to reside. Whichever scenario is relevant, there will be a period between the taxpayer owning the land and the building of the residence.
'Deemed disposal'
Under TCGA 1992, s 223ZA, HMRC will treat this period as their main residence for PPR relief purposes, allowing 24 months from the time the house first became the individual’s only or main residence (the moving-in time) to the date of sale. Note that this section applies only where the delay is due to construction, renovation, redecoration or alteration of the property or because the taxpayer cannot move until their previous residence has been disposed.
Triggering the deemed disposal is particularly beneficial for individuals who were not living in their property before its demolition because that period of non-occupation disappears when the new period of ownership starts.
'Period of absence'
If the deemed disposal conditions are not met (e.g., where there was a house originally on the site which was demolished and replaced), the gap between acquisition and moving in could be covered under the 'period of absence' rules. TCGA 1992, s 223(3) treats certain periods of absence as periods of residence.
Should a project take more than 24 months to complete, PPR relief starts when the taxpayer occupies the property, unless the delay is due to exceptional circumstances beyond their control – more than 24 months, and PPR is restricted.
The recent Upper Tribunal case HMRC v G Lee and another [2023] UKUT 242 (TCC) concerned this exact scenario whereby the land was purchased and the construction of the house was completed more than 24 months after the date of purchase of the land. The taxpayer bought a plot of land in October 2010, demolishing the existing house and building a new house which they then lived in from March 2013. They sold the new property in May 2014 and claimed PPR on the gain. Both properties had been their only or main residence throughout. The taxpayer submitted that the ownership period for CGT purposes was the ownership period for the new house only.
HMRC disputed the claim, stating that the ownership period was from 2010 to 2014, with PPR relief being available only for the period of residence of the replacement house spanning March 2013 to 22 May 2014. This meant that the gain relating to the period October 2010 to March 2013 was not exempt and PPR relief needed to be apportioned. The Tribunal disagreed with HMRC and found in the taxpayer's favour.
Interestingly, Mr Lee had not considered triggering a deemed disposal to reset the period of ownership and create a capital loss. If he had, then HMRC would not have been able to take the case to court.
VAT
If the property is demolished to ground level and then rebuilt, the new dwelling will attract zero-rate VAT, which may save more than the demolition and rebuild costs. However, demolishing only part of the property, such that the subsequent rebuild is classed as an alteration, enlargement or extension to the remaining structure, will not be zero-rated and VAT would be charged on services and materials at the standard rate of 20% (see HMRC’s VAT Information Sheet 07/17). However, where there is a legal requirement (e.g., a statutory planning consent requires retaining a facade of the previously existing building), the work will be zero-rated as the construction of a building.
A new dwelling qualifies for zero-rating VAT provided it does not make use of any part of any existing dwelling, with the following exceptions:
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a cellar or basement (a ground floor slab can be retained);
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retained party walls shared with neighbouring properties (e.g. a terraced or semi-detached house);
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one (two on a corner site) retained façade (only if it is required explicitly in the planning permission); or
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the creation of a new dwelling by adding another storey, addition or conversion involving a change of use.
Detached garages or outbuildings can be retained.
Reduction of VAT rate
There may be instances where VAT is reduced from 20% to 5%, including:
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installation of energy-saving material;
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installation of grant-funded security or heating systems;
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installation of mobility aids for the elderly; or
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renovation of a property which had been empty for two years.
This reduction is valid until 31 March 2027.
In addition, should a residential property have been empty for at least two years, a VAT reduction of 5% is allowed. The intention of introducing this VAT reduction was to encourage the renovation of previously empty residential properties and cover the cost of labour and materials (although not everyday items such as televisions, carpets, etc.).
Practical tip
As detailed above, a section 24 claim is a CGT claim relating only to properties that have been completely demolished. If a property is acquired in a dilapidated condition, expenditure undertaken in repairing and putting it into a fit state for letting may not be allowed as a deduction against rental profits (see HMRC’s Property Income Manual at PIM2025). However, depending on the type of expense, CGT relief may be available on the subsequent disposal (TCGA 1992, s 38(1)(b)).
