IFM24050 - Real Estate Investment Trust : Property rental business income: investment/trading borderline: 3 year development rule: CTA2010/S556
Source: gov.uk (2025-04-17)


If a UK-REIT develops a property with the intention of disposing of it, before or following completion of the development, any gain, loss or profit arises to the residual business. Likewise a disposal of property by disposing of the shares in a property holding company before 6 April 2019 also falls to the residual business.

If a UK-REIT disposes of property used wholly and exclusively in the property rental business, or of interests in a UK property rich company, any gain or loss arising on its disposal may not be treated as a chargeable gain by virtue of CTA2010/S535 and S535A (see IFM25005 (https://www.gov.uk/hmrc-internal-manuals/investment-funds/ifm25005)).

However if a UK-REIT develops a property with the intention of retaining it as part of the portfolio, but sells it (or sells its interest in a UK property rich company that developed a property) within three years of completion, the disposal may be taken out of the property rental business and any gain, loss or profit arises to the residual business (‘3-year development rule’, CTA2010/S556(3) & 556(3A))

Conditions

The 3-year development rule applies to a disposal of a property by a member of a UK-REIT (a direct disposal of property) and also to disposals of interests in a UK property rich company (an indirect disposal of property).

The 3-year development rule applies to a direct disposal of property if all the conditions of CTA2010/S556(3) are met:
- the property has been developed since acquisition,
- the cost of the development exceeds 30% of the value of the property – see below for details of the value to be used,
- the company disposes of it within three years of completion of the development (other than to another member of the UK-REIT).
The 3-year development rule applies to the indirect disposal of property, on or after 6 April 2019, by a company C if (CTA2010/S556(3A)):
- one or more properties acquired (directly or indirectly) by a relevant UK property rich company B have been developed since acquisition,
- the cost of the development exceeds 30% of the value of the property – see below for details of the value to be used
- C disposes of any of its rights or interests in B, not intra-REIT group, within three years of completion of the development.
Value of the Property

For disposals made prior to 1 April 2023, the value of the property is its fair value, determined in accordance with international accounting standards, at the later of the date:
- of entry to the REIT regime
- when the property was acquired.
For disposals made on or after 1 April 2023, the value of the property is its fair value, determined in accordance with international accounting standards (see IFM22040 (https://www.gov.uk/hmrc-internal-manuals/investment-funds/ifm22040)) at whichever of the following times that value is the greatest:
- on entry to the REIT regime
- when the property was acquired
- the beginning of the accounting period in which the development commenced. (CTA2010/S556(3ZA) and (3AA).
Broad descriptions of how HMRC will interpret certain terms in CTA2010/S556 in applying this rule are set out in IFM24060 (https://www.gov.uk/hmrc-internal-manuals/investment-funds/ifm24060). These are “development”, “30% of the cost”, “completion” and “commencement”.

The rules only apply in respect of developments completed after entering the UK-REIT regime, irrespective of when they commenced.

Simply transferring the property from one member of a Group REIT to another would not trigger this rule.

The rule does not say that the disposal is automatically to be taxable as a trading transaction. The transaction moves to the residual business where the normal rules apply to decide if the disposal is by way of trade (income) or investment (capital) in nature.

For direct disposals, if the property was owned when the company joined the regime, the deemed sale and reacquisition at entry to the regime are ignored (CTA10/S556(2)(a)). When calculating the amount of any gain that is taxable in the residual business on a direct disposal, the cost of acquisition will therefore be the original cost of the property to the company, as enhanced by any subsequent capital expenditure. As well as the property reverting to its original cost, the company can claim repayment of any Entry Charge paid in respect of the property (see IFM24055 (https://www.gov.uk/hmrc-internal-manuals/investment-funds/ifm24055)).

For an indirect disposal, CTA2010/S535A does not apply to the amount of the gain accruing on the share disposal that relates to the property (or properties) which have been developed within the company whose shares are being disposed of (CTA2010/S556(3B)). The appropriate proportion of the gain will be calculated in the same way as for CTA2010/S535A but it will not be treated as if it were not a chargeable gain (see IFM25007 (https://www.gov.uk/hmrc-internal-manuals/investment-funds/ifm25007)).

Examples

Case 1 - Direct Disposal

Company C acquired property P on 1 July 2025 for 800, which it rents out for 50 per year net of expenses. When company C enters the UK-REIT regime on 1 January 2026, the market value (and fair value) of property P is 1,000, and the market value of the rest of the property rental business properties is 9,000.

In May 2027, the company completes an extension to the building, commenced in May 2026, with a final cost of 350.The company’s intention was to retain the property but a “too-good-to-miss-offer” is made and company C sells the property for 2,500 in November 2027. The developed property P is sold within three years of completion of the development. The 3-year development rule will apply if the cost of the development exceeds 30% of the greatest of the following fair values of the property:
- on entry – 1 January 2026 (1,000)
- at acquisition – 1 July 2025 (800)
- at the start of the accounting period in which the development commenced – 1 January 2026 (1,000)
The cost of development exceeds 30% of the greatest of these, the fair value of the property at entry to the regime (which in this case is also the start of the accounting period in which the development commenced). The disposal therefore moves to company C’s residual business. In the circumstances, this would probably be regarded as capital and not a trading transaction.

The gain is 1,350 (2,500 – (800 + 350)). The deemed sale and reacquisition on entry at 1 January 2026 is ignored and so the cost of the property at acquisition is used. The gain accrues to and is taxable as part of company C‘s residual business.

Note that although the deemed sale and reacquisition on entry to the REIT regime is ignored, and the property disposal is treated as taking place in the residual business, the rent received for the period 1 January 2027 to November 2027 is still taken into account as part of the profits of C’s tax-exempt property rental business.

Case 2 - Indirect Disposal

Company B, a UK property rich member of UK-REIT group which entered the regime on 1 January 2011, acquired property P on 1 July 2019 for 700, intending to rent it out.

At the time of acquiring P, Company B already held rental property Q.

Company B has no residual business assets.

On 1 January 2021, property P was valued at 800. In October 2021 company B completes a nine month extension project to property P at a cost of 400.

In November 2023, parent Company C sells Company B to an unconnected party and makes a gain of 2000. The gain attributed to property P on disposal is 1500 and to property Q is 500.

The disposal of Company B is:
- within 3 years of completion of the development of property P and
- the cost of that development (400) is more than 30% of the relevant fair value of property P, (800).
The value of 800 is used as it is the greater of the fair value at acquisition (700) and the fair value at the start of the accounting period in which the extension project commenced (800). The property was acquired after entry so there is no third value to consider.

Under CTA10/S556(3B) only that part of the gain on disposal of company B that relates to the property that was developed, being 1500, is taxed in the residual business.

The gain relating to property Q, 500, is not charged to tax as CTA2010/S535A would apply.