Lease Extension: Tax, CGT Deductions and SDLT in 2026/27

Why Lease Length Matters So Much

A residential lease is a wasting asset. As the years remaining on the lease decrease, the value of the leasehold interest declines -- sometimes dramatically. Mortgagors typically refuse to lend on properties with fewer than 70 to 80 years remaining on the lease, and buyers face difficulty reselling. Properties with fewer than 60 years on the lease are often effectively unmortgageable on the open market.

Understanding the tax consequences of extending a lease -- or buying a share of freehold -- is essential for anyone who owns or is considering purchasing a leasehold property.

What Is a Lease Extension?

A lease extension is a legal agreement between the leaseholder and the freeholder (or their collective) to add years to the existing lease, usually in exchange for a premium (a capital payment to the freeholder) and often a reduction in ground rent.

Under the Leasehold Reform, Housing and Urban Development Act 1993 (as amended), qualifying leaseholders have a statutory right to extend their lease by 90 years at a peppercorn (zero) ground rent, provided they have owned the property for at least two years. The premium is determined by a statutory formula that takes into account:

• The value of the freeholder's loss of ground rent
• The freeholder's loss of the right to repossession at the end of the existing lease
• The share of the marriage value (the increase in value created by the extended lease), where the unexpired term is below 80 years

When the unexpired term falls below 80 years, the marriage value element kicks in, which can substantially increase the premium. This is why leaseholders are generally advised to extend while the lease still has more than 80 years remaining.

CGT Treatment of Lease Extension Costs

The Premium: Enhancement Expenditure

The premium paid to the freeholder for the lease extension is classified as enhancement expenditure under the Taxation of Chargeable Gains Act 1992 (section 38). Enhancement expenditure is added to the base cost of the asset and deducted from the capital gain when the property is subsequently sold.

Example:

• Original purchase price in 2015: 250,000 pounds
• Lease extension premium paid in 2020: 25,000 pounds
• Legal and valuation costs for the extension: 3,500 pounds
• Sale price in 2026: 420,000 pounds

CGT calculation:

• Disposal proceeds: 420,000 pounds
• Less: original base cost (250,000 pounds)
• Less: enhancement expenditure (25,000 pounds)
• Less: incidental costs of enhancement (3,500 pounds)
• Less: incidental costs of disposal (legal fees, estate agent -- say 8,000 pounds)
• Chargeable gain: 133,500 pounds
• Less: annual exempt amount (3,000 pounds)
• Taxable gain: 130,500 pounds
• CGT at 24% (higher rate): 31,320 pounds

Without the lease extension costs in the base cost, the taxable gain would have been larger by 28,500 pounds, costing a further 6,840 pounds in CGT. This demonstrates the value of recording and claiming all lease extension expenditure.

Legal and Professional Fees

The legal costs, surveyor's fees, and valuation costs incurred in connection with the lease extension are also deductible for CGT purposes. They fall under either enhancement expenditure (if directly related to the extension) or incidental costs of acquisition (section 38(1)(b)).

Keep all invoices and correspondence carefully, as HMRC may query the deductibility of professional fees during an enquiry.

Does the Property Need to Be Let for the Costs to Be Deductible?

No. The CGT deduction for enhancement expenditure is available regardless of whether the property is your main residence, a buy-to-let, or a second home. However:

• If the property is your main residence throughout ownership, principal private residence (PPR) relief may eliminate most or all of the gain anyway, making the lease extension costs less significant in practice.
• If the property is a let property, the lease extension premium is capital expenditure (not a deductible revenue expense), so it does not reduce your rental income. It only reduces CGT on sale.

SDLT on Lease Extensions

Premium-Based SDLT

When a leaseholder extends their lease by paying a premium to the freeholder, SDLT applies on the premium at residential SDLT rates:

Most residential lease extension premiums are below 250,000 pounds, so SDLT liability is nil. However, for high-value properties in London or other expensive areas, premiums on extensions for shorter leases can exceed this threshold.

The 3% additional dwellings surcharge does not apply to a lease extension of your existing leasehold interest -- because you are not acquiring a new dwelling, you are extending an existing one.

Ground Rent and SDLT on Annual Rent

SDLT has a separate charge for new leases based on the net present value (NPV) of rents payable. For lease extensions that result in a peppercorn (zero) ground rent, this element is nil. Where a non-peppercorn ground rent is agreed, the NPV calculation applies and SDLT may be payable on the rent element if the NPV exceeds 250,000 pounds.

Since the Leasehold Reform (Ground Rent) Act 2022 (discussed below), new residential leases and extensions are generally required to be at peppercorn rent, which eliminates this SDLT concern for most extensions.

Share of Freehold: A Different Approach

What Is a Share of Freehold?

Rather than extending a lease, some leaseholders choose to collectively purchase the freehold of their building -- a process known as collective enfranchisement. Where this is successful, each participating leaseholder typically holds a share in a company (or as a co-owner) that owns the freehold.

Holding a share of freehold:

• Allows leaseholders to extend their own leases (as the freehold company grants the extension) at a nominal or agreed cost
• Provides control over building maintenance, insurance, and service charges
• Protects against freeholder default or mismanagement
• Eliminates the ongoing cost of lease extension premiums to a third-party freeholder

SDLT on Acquiring a Share of Freehold

When a group of leaseholders purchases the freehold, each acquires a share of the freehold interest. SDLT applies on the premium paid by each leaseholder for their share. For collective enfranchisement, each leaseholder's SDLT liability is calculated on their individual contribution to the purchase price, not the total.

If you pay 50,000 pounds as your share of the freehold purchase, SDLT at the 0% rate applies (below the 250,000 pound threshold). If you hold the freehold share in a company, stamp duty (not SDLT) at 0.5% applies to share transfers -- but the initial acquisition by the company is subject to SDLT.

CGT on Selling a Freehold Share

When you later sell your share of the freehold (or the company sells the freehold), CGT applies on the gain. The base cost is what you paid for the share, together with any professional fees. Residential property CGT rates apply (18% or 24%) unless the freehold interest is treated as commercial (which applies where the building has mixed residential and commercial use).

The Leasehold Reform (Ground Rent) Act 2022

The Leasehold Reform (Ground Rent) Act 2022 came into force on 30 June 2022 for new residential leases. It prohibits landlords from charging ground rent above a peppercorn (effectively zero) on new regulated residential leases.

What Changed

• New regulated leases (granted after 30 June 2022) must not require ground rent above a peppercorn
• Lease extensions granted under the statutory right (Leasehold Reform Act 1993) are also required to be at peppercorn ground rent
• Voluntary (informal) extensions and non-residential leases are not covered by the Act

What Did Not Change

The Act applies only to new leases granted after the commencement date. Existing leases with historic ground rents -- including those that escalate periodically (sometimes called "doubling ground rents") -- are not affected and remain in force. However:

• Subsequent legislation is expected to address historic ground rents
• SDLT on existing escalating ground rents remains a concern for buyers of properties with such leases

Impact on Valuations

The elimination of ground rent from new leases reduces the premium payable for statutory lease extensions (because there is no capitalised ground rent stream to compensate the freeholder for). This makes extensions slightly cheaper where the old lease had a meaningful ground rent.

Practical Steps for Leaseholders

If you hold a leasehold property with fewer than 80 to 85 years remaining on the lease, the priority actions are:

1. Get a lease extension valuation from a RICS-qualified surveyor experienced in leasehold reform to understand the likely premium
2. Serve the statutory notice (Section 42 notice) on the freeholder to trigger the statutory process -- this locks in the lease length for valuation purposes
3. Keep all records of costs incurred, from the initial valuation through to the legal completion, as these reduce future CGT
4. Consider whether collective enfranchisement with other leaseholders is viable -- this is usually more cost-effective than individual extensions where the building has four or more flats

Summary

Lease extensions and share of freehold acquisitions have important but often overlooked tax consequences. The premium and associated legal costs reduce the CGT payable on eventual sale. SDLT is nil for most residential extensions (premiums typically below 250,000 pounds). The Leasehold Reform Act 2022 has made new leases and statutory extensions cheaper by removing ground rent. For leaseholders approaching the 80-year threshold, acting promptly to extend avoids the marriage value surcharge and preserves the full tax benefit of the base cost addition.