If you convert a house into flats to keep and let, the building costs are capital: there is no income tax deduction, but the costs are added to the base cost for Capital Gains Tax, and each flat sold later is a part disposal of the original property. If you convert in order to sell, the project is likely to be a trade, so the costs are deducted against the sale proceeds and the profit is taxed as income. Either way, the builder’s work can often be charged at the 5% reduced rate of VAT.

Is the conversion a trade or an investment?

This is the first question, because it decides which tax applies to the profit. There is no single test. HMRC’s Business Income Manual at BIM20205 lists the badges of trade, and several of them bear directly on a conversion: whether the asset was modified or improved to make it more saleable, the interval between purchase and sale, whether the purchase was funded by borrowing that can only be repaid by selling, the number of similar transactions and the intention at the outset. No badge is conclusive on its own; the courts look at the overall impression.

A landlord who buys a house, converts it into three flats and lets them for years is an investor. Someone who buys with a short term bridging loan, converts and sells all the flats as soon as they are finished looks like a trader. The guides to developer or investor status and the badges of trade go into the factors, and the separate anti avoidance rules on property dealing profits can also be relevant.

Can I deduct conversion costs if I keep the flats to let?

No. HMRC’s guidance for landlords says expenses are capital if you add something to the property that was not there before, or alter, improve or upgrade something that was existing. Turning one house into several flats does all of these, so the building contract, new kitchens and bathrooms for the flats, new staircases and partitions are capital. PIM2120 adds that the costs of planning negotiations are not deductible either, and the guidance says that work to make a run down property fit to let is capital rather than repair.

Some smaller costs still get relief:

  • Genuine repairs to parts of the building that are not being altered, such as fixing an existing roof, remain revenue. Our guide to repairs and improvements covers the line.
  • Common parts. Once converted, the building is a block of flats. HMRC’s Capital Allowances Manual at CA23060 says a block of residential flats is not a dwelling house, although each flat is, so plant serving only the common parts, such as a communal fire alarm or a lift, can qualify for plant and machinery allowances. Plant inside each flat cannot.
  • Pre letting costs. PIM2505 explains that revenue costs incurred in the seven years before a property business starts can be deducted when it starts. If you already let other property, preparing the new flats is part of your existing business.

What about the interest on the conversion loan?

PIM2054 says a loan is for a residential letting business if it is for the acquisition, construction or adaptation of the dwelling house in question. For an individual investor, interest on a loan funding the conversion is therefore restricted: it is not deducted from the rental profit but gives a basic rate tax reduction, 20% for 2026 to 2027. Companies are not affected by the restriction.

How is the gain worked out when I sell a flat?

Section 38(1)(b) of the Taxation of Chargeable Gains Act 1992 (TCGA 1992) allows expenditure incurred to enhance the value of an asset, provided it is reflected in the state of the asset when it is sold. Conversion costs are a clear example. Section 38(3) prevents interest from being added to the cost.

Selling one flat while keeping the others is a part disposal under section 42 TCGA 1992. The combined cost of the house and the conversion is apportioned using the fraction A divided by A plus B, where A is the sale price of the flat sold and B is the market value of the flats retained. Section 42(4) says expenditure that is wholly attributable to the flat sold, or to what is kept, is not apportioned, so a kitchen fitted only in the flat sold goes entirely against that sale.

For 2026 to 2027, gains are taxed at 18% to the extent they fall within the basic rate band and 24% above it. A UK residential property gain must be reported and the tax paid within 60 days of completion; see the 60 day property return.

What if the house was my home before the conversion?

Private residence relief can cover the period you lived in the house, but conversion complicates it. Section 224(2) TCGA 1992 allows the relief to be adjusted in a just and reasonable way where what you occupy as your residence changes because of a reconstruction or conversion of a building. Section 224(3) denies the relief on any gain attributable to expenditure incurred wholly or partly for the purpose of realising a gain. Converting your former home into flats to sell is the type of spending that provision targets, so part of the gain can lose relief even though you lived there. See private residence relief when renovating to sell.

What if I am converting to sell?

If the project is a trade, the house is trading stock. The purchase price and conversion costs are matched against the sale proceeds of the flats, and the profit is taxed as trading income rather than as a gain. PIM2054 limits the finance cost restriction to property businesses, so it does not reach interest in a genuine development trade.

Intentions change. If you bought the house as an investment and later decide to convert it for sale, section 161 TCGA 1992 treats you as selling it at market value when it is appropriated to trading stock, crystallising a gain or loss at that point. Section 161(3) lets a trader elect instead to reduce the stock value by the gain, so the whole profit is taxed as trading income later. Our guide to appropriations to trading stock covers both directions.

A developer who lets the flats while waiting for buyers keeps the trade. PIM4300 says rents from trading stock fall into a property business, the letting expenses are set against those rents first, and any excess letting cost is an expense of the development trade.

What VAT applies to the work and the sale?

VAT Notice 708 section 7 allows a builder to charge the reduced rate of 5% on a qualifying conversion. Converting a building, or part of one, so that it contains a different number of single household dwellings qualifies, but work in a part of the building where the number of dwellings is unchanged does not, so refurbishing a flat that is not being altered is standard rated. Paragraph 7.4 also covers converting a house into a multiple occupancy dwelling such as bedsits. See the reduced rate for residential conversions.

On the sale, the zero rate in section 5 of Notice 708 is for converting a non residential building into dwellings. A house only counts as non residential if it has not been lived in for at least 10 years, so most house conversions do not qualify. If the sale is not zero rated, Notice 708 explains that VAT on costs relating to an exempt supply cannot normally be recovered.

How does the part disposal work in numbers?

Illustration only. Hannah, an investor, buys a house for £300,000 and spends £150,000 converting it into three flats, which she lets. Years later she sells one flat for £200,000, when the two she keeps are worth £400,000 together.

Step Figure
Total cost of house and conversion £450,000
Fraction: £200,000 divided by (£200,000 plus £400,000) One third
Cost allocated to the flat sold £150,000
Gain before allowances and reliefs £50,000
Cost carried forward for the two flats kept £300,000

None of the £150,000 conversion cost was deductible against rent, but all of it reduces the gains as the flats are sold.

What mistakes come up most often?

  • Deducting conversion costs from rental income as repairs.
  • Adding loan interest to the Capital Gains Tax cost.
  • Dividing the cost equally between flats instead of using the A divided by A plus B fraction.
  • Assuming a former home is fully covered by private residence relief after a conversion for sale.
  • Not deciding at the outset whether the project is an investment or a trade, and keeping no evidence of the intention.

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Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 19 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.