The increasing popularity of co-living lifestyles is changing how builders build and investors invest. Co-living arrangements are becoming an increasingly attractive alternative to traditional single-family housing for students and young professionals. Not only cost-effective, shared housing often adds a social element as well as on-site leisure facilities, and is considered an innovative lifestyle choice that resonates with the emergence of the sharing economy.
However, the design of co-living arrangements can affect the tax treatment, so planning at an early stage is crucial to avoid increased tax costs. Stamp duty land tax (SDLT) and VAT are two key issues for investors and builders.
With rates of up to 15% applicable on residential dwellings, SDLT is a significant transaction cost. The SDLT rate applied is normally based on the total cost of the transaction: the higher the cost, the higher the rate. However, multiple dwellings relief (MDR) can bring down the SDLT due on a residential transaction.
Broadly, MDR results in SDLT being calculated on the average cost of each dwelling, multiplied by the total number of dwellings, subject to a minimum rate of 1%. One quirk of the tax system means that while student accommodation can benefit from this minimum rate of 1%, co-living developments for non-students are subject to a minimum rate under MDR of 3%.
What this means for investors
As the amount of tax due under MDR depends on the number of dwellings, the issue of what constitutes a dwelling becomes a crucial question. There is also the question of which parts of the buildings are not dwellings, as these are subject to non-residential rates of up to 5%.
What is a residential dwelling?
The generally accepted view is that cooking facilities are required for a room to be considered a dwelling for SDLT purposes. Many rooms in co-living arrangements do not constitute dwellings under this definition. Rather, the larger pod, including the kitchen and several rooms, constitutes the dwelling. This creates a smaller number of more expensive dwellings and increases the SDLT costs of the transaction.
This very traditional view of what constitutes a dwelling for SDLT purposes suggests the tax rules are not keeping pace with societal changes.
Normally, a supply of residential dwellings is exempt from VAT, meaning no input VAT on the development costs is recoverable. However, the first supply of a major interest in land (either the grant of a freehold or the grant of a lease of more than 21 years) is zero-rated, meaning that VAT on development costs can be reclaimed. Careful consideration should therefore be given to the structure of the development to ensure there is in fact a supply of a major interest in land.
The importance of planning ahead
Although these issues create challenges for investors and developers looking to build co-living spaces, there are innovative ways of structuring the development to create a profitable project. Developers and investors need to consider the tax issues on each project on a case-by-case basis to ensure they are fully tax compliant and benefiting from all available reliefs.
David Farr is Real Estate Tax Director at Grant Thornton.