HMRC attack property leaseholders who buy the freehold

The issue

As stories of homeowners being caught out by unfair leasehold practices become more common, it is likely that many owners will start thinking of purchasing the freehold interest in their leasehold properties. This could stop them being caught out by unfair service charges and ground rent, not to mention securing peace of mind.

Such owners may go on to sell their properties (often at higher prices than would be the case if they had not obtained the freehold). They would not expect to pay tax on their main residence due to Principal Private Residence (PPR) relief. At least, according to HMRC, this is not the case!

 

The law

The law says that PPR can be restricted if expenditure has been incurred on a property for the purpose of realising a profit. Obviously, most people who spend money on their properties hope that its value will be increased and so these rules could lead to absurd results. Generally the rules are used to attack people who live in their house for a short period of time while making substantial improvements before an onward sale (although arguably these kinds of transaction should be subject to income tax because they are ‘adventures in a trade’).

 

HMRC example

The example below is a genuine HMRC example and shows the rather aggressive use that they are making of this legislation.

In January 2004 an individual acquires a 99-year lease of a dwelling house with 63 years of the lease remaining, at a cost of £60,000. He uses the dwelling house as his only residence. In 2013 he decides to sell the house. To increase its value, he acquires the freehold for a payment of £40,000 in February 2013. The house is sold in March 2014 for £250,000. The Valuation Office Agency agrees that if the leasehold interest had been sold in March 2014 it would have fetched £160,000.

The part of the gain which is excluded from relief because of the application of TCGA92/S224 (3) is computed as follows.

Total gain
Exempt gain
 Non-exempt gain
£
£
£
1) Disposal proceeds
 250,000
2) Value of leasehold interest
 160,000
Consideration resulting from acquisition of freehold (1) – (2)
       90,000
less Cost of leasehold
(60,000)
(60,000)
less Cost of freehold
(40,000)
(40,000)
Gain
150,000
100,000
50,000

The chargeable gain is £50,000 subject to annual exempt amount.

 

Final thoughts

In the example above, the timing of the freehold purchase may have been a crucial factor. HMRC may have less of an argument to deny PPR relief if the freehold was purchased as early as possible (i.e. two years after moving into the property). We also think that it is arguable whether an individual purchases the freehold to increase its value or to improve their security of tenure. This is probably a point that can be argued out but again it will be stronger if the freehold purchase takes place earlier in the period of ownership.

In any event, this should not put off leasehold owners from making a financially prudent decision to add value to their properties. The worst-case scenario for the individual above is that he would have a £10,000 tax bill in respect of a £50,000 gain, but even then, he would still be £80,000 better off!

 

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