Council house tenants in properties bigger than they need could be forced to move into smaller accommodation under the Government's austerity drive.
Ministers vowed to make the "absurd" housing benefit system fairer, with housing swaps potentially affecting hundreds of thousands of people.
A total of 234,000 households in the social tenant sector are overcrowded while 456,000 are under-occupied, meaning people have more than one extra spare room, according to official figures.
Welfare reform minister Lord Freud said: "We cannot continue with this absurd situation where some of our poorest families have to live in overcrowded conditions while others are subsidised to live in big homes with plenty of spare room.
"It's not fair on those families struggling to get by and it's not fair on the taxpayer.
"That's why, after the benefits free-for-all of the last decade, we are putting fairness back at the heart of the system."
More than three million tenants - 70% of housing benefit recipients - live in the social sector at an annual cost of well over £12 billion.
A Work and Pensions Department spokeswoman said: "From April 2013, we will restrict housing benefit for working age tenants in the social rented sector. This will apply where people live in a property that is too large for their needs.
"We will work with local authorities to ensure that the housing is more sensibly allocated and that entitlement to social housing reflects family size."
The move is likely to prove controversial for older couples who have lived in council houses for decades since their children have left home.
But the spokeswoman added: "Specific policy detail is yet to be agreed but the principle would be that working age housing benefit claimants who are living in a property that is too large for their household size will have their benefit capped."
Almost one million people will see their housing benefit cut by an average of £12 a week next year, it emerged earlier this week.
The British Property Federation (BPF) warned ministers the cuts would lead to "ghettos" and social problems as claimants struggle to find affordable homes.
In his emergency Budget, Chancellor George Osborne said housing benefit payments would be limited to £280 a week for a flat and £400 a week for a house.
The new caps were needed, he said, because the cost of payments had risen 50% to £21 billion over the last decade.
The BPF, which represents property developers and owners, fund managers, investment banks and housing organisations, said the cuts would lead to "real-life personal tragedies".