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Should VAT be included when calculating the rebuild cost of a property?

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The simple answer is that there is no simple answer – except maybe – so let’s take a closer look at why that is so, within the wider context of rebuilding costs in general.

Rebuilding costs 

When arranging any kind of property insurance – whether it is owner occupied, buy to let or commercial – the total building sum insured typically anticipates the worst case scenario in which the property is completely destroyed and needs to be reconstructed.

Such a catastrophic event – like a fire raging out of control, for instance – may result in what is known as a total loss and the building sum insured represents the maximum amount the insurer is obliged to pay out in the settlement of any claim.

To make sure that the property you own may be rebuilt or reinstated, therefore, it is important that the total building sum insured is equivalent to the cost of rebuilding it. 

Calculating rebuilding costs

When calculating a property’s rebuilding costs, it is important to remember that this is just what it means – the cost of reconstructing the building and not its current market value or whatever you happened to pay for it.

The cost of building works naturally varies over time and you might want to consult the online rebuilding and reinstatement cost calculator maintained by the Royal Institute of Chartered Surveyors (RICS) or commission a surveyor or valuer to estimate the current reconstruction costs.

The cost of reconstruction involves far more than rebuilding works, however. As a first step, any remaining parts of the structure may need to be demolished and the site cleared. The services of surveyors, architects and engineers may also be needed to draw up plans for the new works. Solicitors may need to be instructed to take care of the legal requirements and you are likely to have to pay for applications for planning permission.

If the building was of non-standard construction, a listed building, Graded building or one with a thatched roof, your calculation of rebuilding costs may need to take into account the convoluted process of gaining planning permission, the sourcing of more difficult to find materials and the hiring of specialist tradesmen and craftsmen to do the work. This is when you are almost certain to require the professional services of a qualified surveyor.

VAT 

Each one of those elements making up the total cost of rebuilding your property might attract VAT.

But tax matters are rarely anything but complicated and the answer as to whether VAT needs to be included in your calculations depends on a number of circumstances.

A briefing paper prepared by the Chartered Institute of Loss Adjusters (CILA), for example, explains that new building and rebuilding the whole of a destroyed property is zero-rated for VAT purposes, although it remains payable on demolition costs and professional fees (and the appropriate allowance is built into the reconstruction cost calculator published by RICS).

With respect to commercial property, the situation is more complicated still and depends on whether the owner is VAT registered or not. VAT registered companies, for example, are able to reclaim VAT on reconstruction costs (so these do not need to be incorporated into the total building sum insured).

If the owner is unable to recover VAT – as in the case of a residential landlord or property investment company, where no VAT is applied to rents collected – the tax liability needs to be included in any reconstruction or reinstatement costs. This is also the case where a small to medium sized company is not registered for the payment of VAT.

In order to avoid the risk of underinsurance, therefore, CILA advises that VAT liabilities need to be included in the calculation of rebuilding costs.

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