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Unravelling complexities in tax clearance

There are currently 4.2 million leasehold properties in England with around half on leases of under 80 years, making them potentially harder to sell or obtain a mortgage to buy.

A leasehold also means you are liable to pay high costs to extend the lease, alongside maintenance fees, annual service charges and your share of the buildings insurance.

Buying the freehold of a property is ideal as it allows you to gain financial control and as a bonus you get to take control of the property management, maintenance and upkeep.

It usually takes about a year – sometimes longer – to buy the freehold of a property, so once the purchase is complete you may well feel it’s time to celebrate, but your work may not yet done, as there are other elements involved in the process which you may need to undertake.

I’ve bought the freehold so I that I can wave goodbye to my lease

Not quite. Once you have purchased the freehold, the original lease still remains the same even if you now own the part of the block and the land it stands on. It is advisable to ask a solicitor to update anything in the lease that is unjust or poorly written.

A lease can’t simply be cancelled as regulations and legal conditions apply between the freehold company and any flat owners. It may seem strange, but you own a share of the freehold and still have a lease.

 

Taxation complications

Normally when purchasing a freehold collectively with your neighbours in the block, the new leases run for 999 years with nominal ground rent. If these leases are granted quickly after completion, no tax consideration is due.

However where a significant amount of time has passed since the completion of a freehold purchase and the lease agreement, there is likely to have been an increase in the value between what was paid for the share of freehold and the actual value of the new lease extension.

HMRC will then note the higher value than the original contribution if the lease extension is not carried out close to the purchase of the freehold.

The freehold company could therefore be seen as giving a benefit to the flat owner which, for tax purposes, can be seen as making a disposal of value out of the freehold.

This could have unfavourable results for the freehold company in terms of a Capital Gains Tax (CGT). As a consequence of this, another tax charge could befall the leaseholders due to their lease being extended.

Why is tax an added complication?

Granting a lease extension that is worth more than the amount paid for a freehold can result in the freehold company being held accountable for tax liability.

As it is unlikely for the company to have sufficient cash available to meet the liability, HMRC might demand payment from the leaseholder before they approve the lease extension.

 

Tax clearance

In a situation where lease extensions are given many years after completion of the purchase of the freehold, an application can be made to HMRC for a ruling that a large tax bill does not follow – known as a tax clearance.

For a tax clearance to be granted, you would need to show evidence from the date of the freehold purchase to prove that it was always the intention of the lessees to extend the leases to 999 years.

The cost of an application to HMRC for a tax clearance could amount to thousands of pounds.

Ideally, extend your lease immediately after completion of the freehold purchase. As a freeholder, you will only need to cover the cost of the legal fees to do so. Delays in doing so can be extremely expensive and time consuming.

The best way to avoid this situation completely is to make sure that in any freehold purchase the agreement contains a requirement that all participating leases are extended to 999 years on completion or promptly afterwards.

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