Leasehold Property – Capital Gains Tax Issues

Sarah Bradford takes a look at some of the capital gains tax implications of disposing of leasehold property.

Property in the UK can be owned either freehold or leasehold. The owner of a freehold property owns both the building and the land on which it stands outright and in perpetuity. By contrast, a leaseholder has a lease from the freeholder to use the property for a number of years. Leases are normally granted for a long period of time, such as 99 years.

The ‘only or main residence’ exemption for capital gains tax (CGT) purposes applies equally to leasehold and freehold properties. However, a chargeable gain may arise if the exemption is not in point, for example where a leasehold property is purchased as a buy-to-let investment.

Disposal of a lease

A disposal of a lease can take place by assignment or surrender. Where a lease is assigned, the existing tenant passes the benefits and obligations attaching to the lease to the new tenant. This will normally be the case where a leasehold property is sold on the open market. A lease can also be disposed of by surrender. In this scenario, the lease is passed back to the landlord and the lease is generally merged with the landlord’s superior interest (either the freehold or superior leasehold). Regardless of whether a leasehold interest is assigned or surrendered, the tenant disposes of his or her entire interest in the lease. This can have CGT implications.

Long lease v short lease

The length of the lease affects the CGT calculation as different rules apply to long leases and to short leases. A long lease is a lease with a remaining term of more than 50 years at the date of disposal. A short lease is one where the remaining term at the date of disposal is 50 years or less.

Disposal of a long lease

Normal CGT rules apply on the disposal of a long lease and any gain is worked out in the same way as for any other disposal, by subtracting the expenditure incurred in acquiring the lease, together with the costs of acquisition and disposal and any enhancement expenditure from the disposal proceeds. The only or main residence exemption applies in the normal way where the leasehold property has been occupied as the only or main residence for some or all of the period of ownership.

Example 1 – Disposal of a long leasehold flat

Simon purchased three leasehold flats as an investment. The flats have always been let out. He decides to sell one of the flats to release some capital. At the time of disposal, the lease has 91 years to run.

In 2006, Simon paid a premium of £150,000 to acquire the lease. He disposes of it in March 2014 for a premium of £190,000. The incidental cost of acquisition and disposal are £5,000. Simon makes a chargeable gain of £35,000 (i.e. £190,000 – (£150,000 + £5,000)).

Assuming Simon is a higher rate taxpayer and has already utilised his annual CGT exemption for the year, he will be liable to pay CGT of £9,800 on the disposal (i.e. £35,000 @ 28%).

Disposal of a short lease

The disposal of a short lease (i.e. one with a remaining term of 50 years or less at the date of disposal) is more complicated. This is because a short lease is regarded as a ‘wasting asset’. However, it does not waste uniformly over time as the rate of decline in value increases as the remaining term decreases. As a result, special rules apply to determine the amount of the allowable expenditure that is wasted, as the wastage does not occur on a straight line basis. The rules apply if the lease was a short lease at the date of disposal, regardless of whether the lease was a long lease with more than 50 years to run at the time at which it was acquired.

Thus the short lease rules apply if there are less than 50 years remaining upon disposal of the lease, even if the lease was a long lease when it was acquired.

The allowable expenditure is reduced under special rules to take account of the fact that the asset is a wasting asset.

As regards acquisition expenditure, the amount that is excluded is the fraction given by the formula:

P(1) – P(3)
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P(1)

Where P(1) is the percentage from the table below at the beginning of the period of ownership and P(3) is the percentage applying at the time of disposal.

Where expenditure has been incurred during the lease which enhances the value of the lease, the enhancement expenditure is reduced by the fraction:

P(2) – P(3)

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P(2)

Where P(2) is the percentage applying at the date that the enhancement expenditure was incurred.

The table (from TCGA 1992, Sch 8, para 1) is as follows:

Years remaining	Percentage	Years remaining	Percentage
50 (or more)	100	25	81.100
49	99.657	24	79.622
48	99.289	23	78.055
47	99.902	22	76.399
46	98.490	21	74.635
45	98.059	20	72.770
44	97.595	19	70.791
43	97.107	18	68.697
42	96.593	17	66.470
41	96.041	16	64.116
40	95.457	15	61.617
39	94.842	14	58.971
38	94.189	13	56.167
37	93.497	12	53.191
36	92.761	11	50.038
35	91.981	10	46.695
34	91.156	9	43.154
33	90.280	8	39.399
32	89.354	7	35.414
31	88.371	6	31.195
30	87.330	5	26.722
29	86.226	4	21.983
28	85.053	3	16.959
27	83.816	2	11.629
26	82.496	1	5.083
		0	0

Example 2 – Disposal of a short lease

Caroline acquires a leasehold flat in 2008 for a premium of £90,000. At that time, the lease had 51 years remaining. She disposes of the lease in 2014, assigning it for a premium of £120,000. The flat was let out for the entire period of ownership.

At the time of disposal, the lease had 45 years left to run and consequently the lease is a short lease at the time of disposal, and the allowable expenditure is reduced by the fraction:

P(1) – P(3)

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P(1)

P(1) is 100%, as at the time of acquisition the number of years remaining on the lease is more than 50.

P(3) is 98.059 (the percentage in the above table applying to a lease with 45 years to run).

The allowable expenditure is computed as follows:

Premium paid for lease 90,000

Reduction

100 – 98.059 x £90,000 (1,747)

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