Capital Gains Tax and Inheritance Tax –  considerations for farming land held with development potential

 

This article reviews the capital gains tax and inheritance tax considerations for farming land held with development potential.

Basic Capital Tax Rules and Reliefs

In the event that land is sold, the standard capital gains tax rates are 10% up to the basic rate band and 20% thereafter.  

There are three capital gains tax reliefs which may be applicable in the event of a disposal:

  1. Entrepreneurs Relief
    This relief reduces the tax rate on all amounts to 10%.  It is likely to be achieved when the sale of land constitutes the disposal of part or whole of a business.  The interest must have been owned for at least two years prior to disposal.  Selling the land alongside a permanent cessation of farming activity is therefore likely to qualify.

     

  2. Gift holdover relief
    This relief defers any capital gains tax if assets are gifted until a future disposal.  One of the types of assets on which this relief may be claimed is for gifts of agricultural land.  This means that gifts to say children could defer any gain until a future sale.

     

  3. Business asset rollover relief
    This relief defers capital gains tax if the proceeds of a sale of business assets are reinvested in new business assets one year prior or within 3 years after a sale.  

Where there are assets that are not used in a business (eg farm buildings rented out) all of these reliefs may be restricted on a just and reasonable basis for these investment activities.

Basic Inheritance Tax Rules and Reliefs

For inheritance tax the rate of tax on death is 40% based on value above £325k (not counting the residential nil rate band).  There are two main reliefs that apply in this circumstance.  These are as follows:

  1. Agricultural Property Relief (APR)
    APR is available on land used for agricultural purposes providing it has been farmed by the owner for 2 years or someone else for 7 years.  Although this relief is given at 100%, it only applies to the agricultural value of the land and possibly the farmhouse, so
    APR will not be hugely helpful where land has significant development value.

     

  2. Business Property Relief (BPR)
    If both APR and BPR are relevant APR takes priority but BPR would cover the remaining value of the land.  It is important that the partnership agreement supports the fact that the land is a partnership asset and does not allow for a definite contract of sale on death.  An option for the other partners to acquire the interest is preferable, as is a clear land capital account showing in the partners’ accounts. Again there may be a restriction in relief to the extent that any buildings are let out although this may not be the case where the level of letting income and time spent is minimal.

If a partner is married, IHT will only be calculated on the second death of a married couple.  This is on the assumption that all assets are initially left to the surviving spouse.

A further consideration is BPR replacement relief.  This means that if an asset qualifying for BPR is sold and the proceeds are invested in another qualifying asset, that asset immediately qualifies for BPR. This might be useful if the proceeds are reinvested in another business.    

POSSIBLE OPTIONS

Where a farming partner has development land there are a number of options that can be considered:

  1. DO NOTHING AND PARTNERS PASS AWAY PRIOR TO DISPOSAL OF THE LAND

Providing BPR is available, the asset will pass to the next generation tax free.  Currently the availability of BPR is uncapped so the value of the land will not affect this.  When the land is subsequently sold the next generation will benefit from a capital gains tax uplift and will therefore pay tax only on the difference between the value on death and the disposal proceeds.  This will be taxed at 20% unless the next generation actively farm the land (probably as partners) for a period of 2 years prior to sale, in which case they will benefit from the 10% tax rate.

  1. DO NOTHING AND LAND IS SOLD PRIOR TO PARTNERS PASSING AWAY

In this circumstance the partners would be subject to capital gains tax on the disposal proceeds.  If partners were to use the disposal as a trigger to exit the partnership then they would likely pay tax at 10%.  If, however, partners continued to act as farmers then the majority of the gain would be taxed at 20%. 

After the sale the partners would have a significant amount of cash.  This cash would be subject to inheritance tax on death, mostly at 40%.  The partners could gift cash to the next generation and apart from a few exemptions this would take 7 years to fall fully out of their estate with taper relief reducing the IHT due after 3 years.

In order to reduce the IHT due, the partners could consider an investment that would take advantage of BPR replacement relief, providing the investment was made within 3 years.  This could take the form of an investment in a new trading business of any description or there are tailored investments from financial providers that achieve the same result. 

  1. TRANSFER TO THE NEXT GENERATION AND PARTNERS PASS AWAY PRIOR TO DISPOSAL OF THE LAND

Gifting an interest in the partnership land should not trigger an immediate tax charge as the  conditions for holdover relief should be met.   On a future disposal, providing the next generation join the farming partnership, they should benefit from Entrepreneur’s Relief, providing they have owned the interest for at least 2 years.  

The gift will also start a 7-year clock for inheritance tax purposes, so if the land is sold in the future,but the partners do not survive 7 years from the date of the gift, then IHT may become payable.  However, the IHT will be calculated based on the value of the land at the point of gift, which would be expected to be less than any future sales proceeds.  There would also be taper relief providing the partners survive for at least 3 years from the date of the gift. 

  1. TRANSFER TO THE NEXT GENERATION AND LAND IS SOLD PRIOR TO PARTNERS PASSING AWAY

Gifting an interest in the partnership landshould not trigger an immediate tax charge as the conditions for holdover relief should be met.   On a future disposal, providing the next generation join the farming partnership, they should benefit from Entrepreneur’s Relief, providing they have owned the interest for at least 2 years.  

The gift will also start a 7-year clock for inheritance tax purposes, so if the land is sold in the future,but the partners do not survive 7 years from the date of the gift, then IHT may become payable.  However, the IHT will be calculated based on the value of the land today, which is clearly going to be less than any future sales proceeds.  There would also be taper relief providing the partners survive for at least 3 years from the gift. 

A final consideration is whether the partners are to benefit from the proceeds of the sale in the future.  If, for example, the next generation made gifts back to the partners, HMRC could challenge the legitimacy of the gift for inheritance tax purposes in the first place.

Note that in the event that the land is gifted and it is sold after 7 years, then there would be no IHT to pay and the next generation, as partners, could benefit from Entrepreneurs Relief on the sale.

TRANSFER A PROPORTION OF THE LAND

A transfer of a proportion of the land may create a solution that manages the tax uncertainties at least to some degree.

OTHER CONSIDERATIONS
As well as tax the partners may wish to consider the loss of control in gifting assets to the next generation.  Even where families are close, issues could arise from either the next generation, any bad relationships or creditors if they fall on hard times.

All partners should ensure that they retain sufficient assets to meet potential future needs, for example to have choices if long term care is needed and conversely, cannot be challenged for deprivation of assets if substantial gifts are made.   It is also important to demonstrate that the gifts are full and final and there is not an expectation that proceeds will be lent of gifted back to the partners as this could be deemed to be a gift with reservation or potentially give rise to pre-owned asset charges.

CONCLUSION
Notwithstanding long-term implications such as Brexit and changes in tax policy, the difficulty in these situations is typically IHT.  Whilst lifetime gifts might mitigate the position, if proceeds are received within 7 years the potentially exempt transfer rules will be in point.  However, locking in the value of the gifts at a certain date can be valuable where value is likely to increase as development becomes more of a reality.  There is always uncertainty over the date of death and the date of sale and tax planning therefore needs to be practical and involve an element of hedging ones bets.

The Tax Recruitment Company and its directors and staff do not provide tax, legal, or accounting advice. This communication/material has been prepared for general information purposes and guidance only. This communication/ material does not constitute tax, legal, accounting or other professional advice, and should not be relied on or treated as a substitute for any such specific advice relevant to particular circumstances.  You should consult your own tax, legal and accounting or other professional advisors for any specific advice following receipt of this communication/material.  

The Tax Recruitment Company and its directors and staff do not provide tax, legal, or accounting advice. This communication/material has been prepared for general information purposes and guidance only. This communication/ material does not constitute tax, legal, accounting or other professional advice, and should not be relied on or treated as a substitute for any such specific advice relevant to particular circumstances.  You should consult your own tax, legal and accounting or other professional advisors for any specific advice following receipt of this communication/material.

The Tax Recruitment Company and its directors and staff do not provide tax, legal, or accounting advice. This communication/material has been prepared for general information purposes and guidance only. This communication/ material does not constitute tax, legal, accounting or other professional advice, and should not be relied on or treated as a substitute for any such specific advice relevant to particular circumstances.  You should consult your own tax, legal and accounting or other professional advisors for any specific advice following receipt of this communication/material.

The Tax Recruitment Company and its directors and staff do not provide tax, legal, or accounting advice. This communication/material has been prepared for general information purposes and guidance only. This communication/ material does not constitute tax, legal, accounting or other professional advice, and should not be relied on or treated as a substitute for any such specific advice relevant to particular circumstances.  You should consult your own tax, legal and accounting or other professional advisors for any specific advice following receipt of this communication/material.

The Tax Recruitment Company and its directors and staff do not provide tax, legal, or accounting advice. This communication/material has been prepared for general information purposes and guidance only. This communication/ material does not constitute tax, legal, accounting or other professional advice, and should not be relied on or treated as a substitute for any such specific advice relevant to particular circumstances.  You should consult your own tax, legal and accounting or other professional advisors for any specific advice following receipt of this communication/material.

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