With a current Government target of 200,000 more homes to be built each year in the UK, many farming families own land that carries development potential either now or in the future. Farm buildings and barns may similarly have ‘hope’ value attached to them. But with an increase in value comes the potential for an uplift in tax on any sale or transfer. Careful forward planning can assist with minimising this for current and future generations.
Inheritance Tax (IHT) on property with development value can be punitive. The fact that land qualifies for agricultural property relief (APR) may be of little assistance. This is because APR only applies to the ‘agricultural value’ of land or property and the calculation of agricultural value assumes that the land can only ever be used for agricultural purposes. Where land has development potential the agricultural value will accordingly be significantly below the ‘market value’. It is the market value that HMRC is concerned with and so, unless business property relief (BPR) applies (see below) tax at 40% may be levied on the difference between agricultural and market value.
So for example, if a piece of land that does not qualify for BPR has development value of £2m and agricultural value of £100,000 (qualifying for 100% APR) on the death of the landowner, tax at 40% could be applied to £1.9m (assuming their nil rate band is used up by other assets). This would result in a tax bill of £760,000.
To avoid the painfully expensive consequences of a scenario like this, it is important to structure land ownership and occupation, so that BPR applies. This is because, unlike APR, BPR will cover ‘hope’ value relating to development. If the above piece of land was owned by an individual, but farmed by a partnership in which they were a partner or a company of which he had control, then the hope value would qualify for BPR at 50% reducing the tax to £380,000. However, if the land were held within the partnership or company itself, or farmed in hand by the landowner as a sole trader, then the hope value element could qualify for BPR at 100%, reducing the IHT to nil. This makes correct structuring of the land ownership and occupation critically important.
Selling land and realising development gains during lifetime can also create an IHT issue, as cash will attract IHT at 40% on death unless passing to a spouse or charity. Where a sale of development land is planned during the lifetime of a landowner, gifting the land into a trust for the benefit of the next generation at an early stage should be considered. Ideally this should be prior to planning permission being obtained and while the land qualifies for IHT reliefs to avoid any lifetime IHT on entry into the trust. Careful planning is required as there are tax clawback provisions if the landowner making the gift dies within seven years and the land does not still qualify for IHT reliefs at that time.
Capital Gains Tax
A sale of land during the lifetime of an individual landowner may give rise to a Capital Gains Tax (CGT) liability on the profit element of the value.
The gain is likely to be taxed at 28% unless Entrepreneurs’ Relief (ER) applies, in which case the gain will be taxed at 10%. ER will only apply if the gift or sale constitutes a disposal of the whole or part of a business or the disposal of business assets when the business ceases to operate. With careful planning it may be possible to fall within these rules so that the individual landowner benefits from the lower rate of CGT. However, this is fact dependent and should be considered before there is a sale in the offing. This allows the landowner to understand their current position and, in turn, consider whether it can be improved.
Alternatively the gain can be ‘rolled over’ if the sale proceeds are reinvested in the purchase of other qualifying business assets. Roll over relief can apply to reinvestment in furnished holiday lets, including the development of barns for this purpose.
Holdover relief should apply to land qualifying for IHT reliefs or being gifted into a trust.
The straightforward sale of farmland should, in most cases, be treated as a capital disposal. However, landowners should be aware that part of any gain could be subject to income tax if, for example, the landowner starts to develop the land or transfers the land to someone else when a future sale is likely. The highest rate of income tax is 45%, so the difference in tax liability would be significant if a landowner inadvertently fell within these rules.
The tax issues relating to development land are complex and a thorough review and careful planning is required in all cases at the earliest opportunity.
The content of this article is for general information only. If you would like more information on development land and farming families, please do not hesitate to contact Lorna Spear or Karl Pocock. Law covered as at January 2016.