Lease extension – tax implication?

Key Considerations:

Allocation of the Freehold Purchase Cost
Since the vast majority of the £20k purchase price is attributable to your own flat’s lease extension (because the other two flats have long leases and nominal ground rent), you need to ensure that this cost can be added to your base cost for CGT when you sell.

Lease Extension Without Consideration
If you and your wife (as joint freeholders) simply extend the lease without charging yourself, HMRC might argue that no "market transaction" took place, which could make it difficult to claim the cost as part of your capital base.
A possible risk is that HMRC may view this as an enhancement to the property, but without a clear cost allocation, they could challenge its inclusion in the CGT base.

Valuation and ‘Paper Transaction’
One solution is to have a formal valuation of the lease extension and explicitly document a lease premium (i.e., a price for the lease extension). This could be set at a nominal value, but it must be commercially justifiable.
The lease extension should ideally be completed via a formal agreement where your freehold entity (you and your wife) grant the extension to your leasehold interest.

Tax Implications of Charging a Premium for the Lease Extension
If your freehold entity (you and your wife) charges you (your leasehold interest) for the lease extension, the premium you pay can be added to your flat’s capital cost for CGT purposes.
However, this would generate a taxable gain for you and your wife as freeholders. Since the freehold cost was low, there might be a profit element subject to CGT.

Possible Way to Structure It:

Step 1: Buy the Freehold in Joint Names
This is already your plan, which avoids issues of owning the lease and freehold in the same name.

Step 2: Obtain a Professional Valuation of the Lease Extension
This should reflect a fair market price for extending a 56-year lease to, say, 999 years.

Step 3: Formal Lease Extension with a Consideration
You could set a premium that reflects the proportion of the freehold cost that relates to your flat’s lease extension.
This premium should be formally documented and paid from your leasehold interest to your freehold ownership.
This allows the cost to be included in your flat’s base cost for future CGT.

Step 4: Minimize Tax Impact for the Freehold Sale
If the premium for the lease extension is roughly equal to the cost of the freehold purchase attributable to your flat, the gain on the freehold side should be minimal.
Since you and your wife each have a £6,000 CGT allowance (2024/25 rates), any small gain might be covered by allowances.

Alternative Approach – No Charge for Lease Extension

If you decide to grant yourself the lease extension without any consideration:

You may still be able to argue that the cost of acquiring the freehold should be allocated to the leasehold interest in future CGT calculations.
However, the risk is that HMRC might challenge this, as there is no actual transaction showing a capital cost increase.
This approach is simpler but comes with some uncertainty regarding CGT treatment.

To ensure the freehold purchase cost is properly reflected in your CGT calculation:

A formal lease extension with a market-based premium is the safest approach.
If you and your wife set the premium close to the relevant proportion of the freehold purchase price, the tax liability should be minimal.
A professional valuation would strengthen your position with HMRC.

Do you need to extend the lease once you effectively own the freehold? If you ever sell the flat, you could simply include the freehold. There would be little point in hanging onto the freehold at that point as there are probably only Costs/liabilities and no benefits associated with it anyway.

I'm not sure about the CGT implications, but I also don't see why you need a lease of your flat if you own the freehold. If you buy the freehold in your sole name, you can merge the leasehold interest into the freehold. Surely HMRC will recognise the reality that the freehold purchase cost is part of the base cost of your flat?
When you sell, the buyer will have to be willing to take on responsibility for maintenance of the building and collection of service charge contributions from the other flat owners. If major repairs are required and you can't reach agreement with the other flat owners, then you may need to appoint managing agents to manage the process. It might be worth thinking about whether it would help to collect a reserve fund, but then you'd have to keep the money in a deposit account until it was needed. You'd have to check the long leases of the other flats to make sure a reserve fund can be collected.

As has been said you can buy in sole name. You can be your own freeholder you just can't grant a lease to yourself.
Leave the short lease then just grant a new one when you sell. CGT then simple.

If you merge your lease with the freehold, you could eventually sell your flat by granting a new long lease to the buyer and then transfer the freehold to the three flat owners so that they all own it jointly. Good point by Londonlad, but I do think it's worth merging the existing short lease with the freehold (and closing the leasehold title for your flat) so that it's not hanging about being redundant and confusing.

Reply to the comment left by Neil Patterson at 10/03/2025 - 09:36
Neil, thank you for taking the time to provide this detailed view - all of which makes sense to me including the opinion that their will be little value left in the freehold after the extension so therefore little or any capital gain which would certainly be covered by our allowances.

Reply to the comment left by DPT at 10/03/2025 - 10:23
Thanks - the flat is mortgaged so a lease extension would allow this to be re-financed at a better rate now

Reply to the comment left by Kate Gould at 11/03/2025 - 22:46
Thank you. I hadn't considered merging the interests but I would be slightly concerned about selling the flat later in this scenario. I think having a separate lease is a little cleaner and may be what most lenders will expect to see.