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A scheme of capital allowances for the conversion of upper floors of commercial premises to residential use has been announced. It is subject to EU approval.
It may seem paradoxical that in a year in which investors in residential property are being heavily penalised with a view to driving them out of the property market, the government should announce a scheme of tax incentives to encourage landlords to provide residential accommodation.

The paradox can be resolved. The new incentives for providing apartments over commercial property apply almost entirely to the conversion of existing accommodation and would have no impact on the demand for building land. It is therefore aimed at a part of the residential property market which is not sensitive in the current housing climate.

Five cities
The new incentives will be available in five cities only. These are Dublin, Cork, Waterford, Limerick, Galway. All five cities were the subject of a similar tax incentive introduced in 1994, which was a conspicuous failure.

The incentives will be available only in a limited number of streets in each town. The streets will be selected by the local authority on advice from an expert panel, which has been nominated. The maximum length of streets in total which may be selected for the incentives in Dublin amount to only 5,000 metres. The other towns receive a lower allocation. The scheme is therefore likely to be of very limited impact, even if it were a success.

Some limited amount of new building will be permitted where the needs of the streetscape require it eg where the top half of a building is missing at present (due to earlier dereliction) or where the provision of access or toilet facilities etc to the upper storeys requires new building. But in general the incentives are available only for the conversion of the upper floors of existing properties to residential use. In every case the ground floor must be in commercial use.

The tax breaks
The incentives will be available both to owner occupiers and to investors. The owner occupiers will receive an allowance of 100% of the refurbishment expenditure over a ten year period. The investor will receive s23 type relief ie the entire refurbishment cost will be offsetable against Irish rental income, potentially 100% in the year in which it is incurred, if there is adequate income to absorb it. There is no potential for the investor to offset the allowances against non rental income, whereas the owner occupier may do so.

The objectives of the scheme are obviously worthy. They aim to combat dereliction due to upper floors being left empty and kept poorly repaired in consequence. They aim to provide some additional residential accommodation, although the scheme is so limited that its impact in this area should be minimal.

It also aims to bring back a bit of life into some streets that are deserted at night. However many of the streets which will be designated are in all probability streets that are far livelier at night than they are in the day time, due to Dublin’s burgeoning night entertainment scene!

The tax penalties
The policy in the area of residential housing has now become so complex that a property owner who decides to develop the upper floors of his commercial property, and convert them to residential use could face tax penalties as well as becoming entitled to tax breaks!

Many commercial properties are owned by family companies. If rental income arises in a closely held company it is liable to tax there at the higher corporation tax rate of 25%. This compares to the corporation tax rate of 20% that will apply in 2001 to trading income in a company. Furthermore if such rental income is not distributed to the shareholders by way of dividend etc, an additional surcharge is applied to the company which brings the tax cost up to 40%. If to avoid the surcharge the rental income is distributed as a dividend, there will be an additional 44% tax cost in the hands of individual shareholders.

The conversion work which attracts the capital allowances has to be financed from somewhere. If it is financed from borrowings, the interest on those borrowings will not be deductible either against trading income (since not incurred for a trade purpose) nor against rental income, in computing tax. The disallowance of interest in computing trading income from a residential property was brought in following one of the Bacon reports, to discourage investors from entering the housing property market.

Furthermore, should the company subsequently seek to sell the property they will find that it will in part attract a 9% stamp duty rate, rather than the 6% that would otherwise have applied. That raises the prospect of the resale price being reduced by 3%.

It would be sensible to remove the surcharge on rental income arising from these properties; allow an interest deduction against the rental income; and disapply the 9% stamp duty rate to these properties. What is the point of offering a carrot to the donkey, and using the stick on him if he accepts it?

Property owners viewpoint
It is undoubtedly the case that the upper floors of many commercial buildings lie idle or under utilised. Property owners are generally not fools and can be assumed to consult their own best interests. There are probably therefore valid reasons why they do not sub-let these upper floors for residential use.

These reasons might include fears that it will compromise the security of the commercial premises on the ground floor; the administrative bother of handling residential tenants; the wish to preserve the space in case of the need for expansion in the future; and a fear that having parted with possession of the premises, they will have difficulty in getting it back. The latter fear cannot be assisted by the current move towards improving security of tenure for residential tenants.

It is doubtful if the new tax incentives will lead to property owners carrying out conversion work where they would not otherwise do so. Where however a property owner was contemplating such work in any event, the incentives could be decisive in causing them to commence work now. For that reason hopefully there will be consultation with property owners before streets are designated, so as not to waste designation on streets where property owners are not likely to react in any event.

One very welcome feature is the increase in the minimum apartment size provided for under the scheme. The minimum will be 55 square metres. No maximum size has been prescribed to date although there is always a risk that this will be included in legislation. To date the provision of maximum apartment sizes in Urban Renewal legislation has been a disaster. It has contributed to the inadequate size of many apartments provided under the Urban Renewal schemes, to the long term detriment of tenants, landlords, and the country as a whole.

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