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COVID 19 – Changing commercial buildings for good?

Date: May 13, 2021

Where we’ve been …

In 2020 many business leaders were left with the unenviable decision to send their workforce home with no return date in sight.

Many of them didn’t see some team members ever again, whilst others are now awaiting a time when they can reunite with employees, colleagues, and friends over a glass of something alcoholic.

But the past year has surely changed the landscape of how commercial property is used forever.

 

The scenario …

Picture a commercial landlord – they own an office block and have done since 2006 when they purchased it for £2,000,000.00.

The building comprises of 6 floors, rented out to 3 companies, with a combined rent of £600,000 per year.

The income generated has enabled the landlord to finance their kids’ education, paid for stunning holidays, and has even financed other property purchases.

It’s now 2022, and one by one the tenants in the building approach the landlord stating the following;

• We need to downsize, our workforce is now 100% digital.. therefore we only envisage 5 members of staff a day in the office; therefore, we are terminating our lease
• We only need 1 floor as opposed to two
• We need to watch our cash flow, we want to stay here but can only justify it if we can negotiate terms

All of these have the same potential outcome .. the landlord seeks to change the buildings from “commercial to residential split”.

So it is now 2025, and the landlord is making MORE from the building than ever before as 3 floors are commercial with 3 floors above converted to luxury apartments.

The rental income has now gone to £800,000 and the landlord has moved the building into a LTD company entity after consulting with their accountant.

 

A missed opportunity …

The client looks into the issue one day about tax relief via Capital Allowances on commercial property having spoken to a specialist.

An exercise is carried out on the building and the landlord is disappointed to learn that 50% of the building has now been erased for good in terms of relief from Capital Allowances.

This is because residential use, even if rent is received, is limited to plant and machinery located in communal areas such as stairwells/landings only – not the dwellings themselves.

The bottom three floors which are still offices are OK as there is a qualifying activity going on in them, but it’s still a big chunk of relief lost.

 

How the numbers look…

Using the numbers in the scenario above, here is how COVID could catch out the landlords in the future;

Pre COVID:

• 100% of £2,000,000 building was commercial
• Capital Allowances exercise identified 20% of the purchase price in qualifying plant and machinery
• Allowances identified £400,000
• Property owned via a partnership @ 40% therefore, total relief available via allowances = £160,000

Post-COVID:

• 50% of £2,000,000 building is now commercial
• Only £10,000 of qualifying expenditure identified in communal areas
• Capital Allowances identified remain at 20% in parts of the building still used for commercial use
• Allowances identified £210,000
• Property now owned in a LTD entity @20%; therefore, total tax relief available via allowances = £42,000

 

It’s so easy to miss out …

Whilst £42,000 is not to be sniffed at you can clearly see how amending a building’s use is great for addressing income yields but can have knock-on effects with regards to tax relief moving forward.

We would recommend Capital Allowances are reviewed PRIOR to amending a building’s use, and also prior to changing the ownership entity.