Tax Implications of Extending Your Lease by 999 Years

Nikka Sulton

Tax Implications of Extending Your Lease by 999 Years

Pooling resources to collectively purchase the freehold of their building is a familiar strategy among flat leaseholders. This move offers several compelling advantages, including:

Improved Building Management: Dissatisfaction with the current management practices of the existing freeholder often prompts leaseholders to take matters into their own hands. By assuming control over building management, they seek to ensure more effective maintenance and upkeep, tailored to their needs and preferences.
Addressing Negative Perceptions: With mounting concerns about the pitfalls of leasehold ownership, such as rising ground rents and restrictive clauses, leaseholders are eager to mitigate these issues. Acquiring a share in the freehold allows them to eliminate these concerns, thereby enhancing the market appeal and value of their flats.

In essence, the decision to pursue a collective freehold purchase stems from a desire for greater autonomy in building management and a proactive effort to bolster the attractiveness and value of their properties in a competitive real estate market.

Even with a share in the freehold, it’s crucial to recognize that lease extension remains a vital consideration, given its status as a distinct interest and a diminishing asset over time. One of the significant advantages associated with having a share in the freehold is the potential to grant each participating leaseholder an extensive 999-year lease term. However, in cases where there are more than four individuals involved in the purchase of the freehold, it’s prudent to establish a company to facilitate the acquisition process. This corporate entity can then oversee the process of granting the extended leases to individual leaseholders, a step that should ideally occur promptly following the completion of the freehold purchase transaction.

Nevertheless, before proceeding with the lease extension process, it’s imperative for the company to conduct a thorough assessment of its financial obligations, particularly regarding potential liabilities such as Capital Gains Tax (CGT) and Stamp Duty Land Tax (SDLT). Neglecting to address these considerations adequately could result in significant tax implications for both the company and its individual leaseholders. Therefore, careful planning and consultation with legal and tax advisors are essential to mitigate potential risks and ensure compliance with relevant tax regulations throughout the lease extension process.

The fundamental query to address pertains to the ownership structure of the freehold asset. Is it held as an asset of the company, or is it maintained on trust for the leaseholders of the building?

If the freehold is owned by the company as an asset, it is probable that there will be Stamp Duty Land Tax (SDLT) implications. Therefore, it is crucial to verify that the freehold is held by the company on trust for the leaseholders to potentially mitigate SDLT implications.

How do you ensure that the freehold asset is held on trust for the leaseholders?

A deed of trust serves as a practical tool for clarifying the tax implications involved. Typically drafted alongside the participation agreement, it explicitly outlines that the freehold asset is held in trust for the leaseholders of the company.

In the event of an absence of an explicit deed of trust, scrutiny of the company’s accounts can offer insights. If the freehold building isn’t listed as an asset of the company, this absence could be indicative of an implied trust. Furthermore, if a shareholder’s resolution has been documented, expressing the company’s intent to pursue lease extensions, it could provide further evidence of an implied trust.

Failure to demonstrate that the freehold asset is held in trust for the leaseholders may result in Stamp Duty Land Tax (SDLT) obligations on the lease extension’s value, irrespective of any financial transactions associated with it.

Lease extensions and Capital Gains Tax

Lease extensions fall within the scope of Capital Gains Tax (CGT) regulations.

If a company grants a lease extension to a leaseholder long after acquiring the building, the value of the extension may significantly differ from the initial cost of purchasing the freehold. This variance could be viewed as the company disposing of a valuable asset, potentially resulting in a CGT liability. In such cases, the company might seek reimbursement from the leaseholders for this liability.

To mitigate the risk of leaseholders bearing the company’s CGT liability, it’s crucial to conduct lease extensions promptly after acquiring the freehold and establish a deed of trust. This arrangement ensures that leaseholders are the beneficiaries of the trust, safeguarding them from potential tax obligations.

Seeking professional tax advice is essential to understand your tax status accurately. For tailored guidance, consulting a qualified tax advisor is recommended.

Our enfranchisement team specializes in advising on the legal aspects of extending leases, whether pursued individually or collectively.

Assignment of a lease

The tax implications for assigning a lease vary based on whether it’s classified as a long or short lease.

A long lease refers to one with over 50 years remaining at the time of sale, while a short lease has less than 50 years left to run.

Assignment of a long lease

Calculating capital gains tax (CGT) on a long lease assignment follows a simple process: subtract the original cost from the proceeds, and the resulting gain is subject to CGT after considering any applicable annual exemption.