Let Property and IHT pitfalls

Let property – investment not trade

The future inheritance tax (IHT) bill that will be due on let property is something that keeps many tax advisers awake at night.  There are disadvantages suffered by the UK landlord in tax terms, in that the owning of property is still not considered to be a trade, property ownership is deemed to be an investment.  Income tax losses arising from property ownership cannot generally be offset against total income in the way that trading losses can.

For those farmers looking to let land on a farm business tenancy (FBT) or turn redundant cottages in to residential lets, there are several IHT planning areas to consider.

Letting farmland

The good news is that let farmland qualifies for Agricultural Property Relief (APR) for IHT purposes on the agricultural value of the farmland at the rate of 100% or 50%.

However, as the letting of land is not a trade Business Property Relief (BPR) cannot be applied to the market value should the market value exceed the agricultural value. The market value of land will exceed the agricultural value when there is the possibility of developing the land for residential or commercial purposes.  The difference is known as ‘hope value’ or ‘development value’ and APR is restricted to the agricultural value of the farmland.  If, for example, 100 acres on the edge of a village earmarked for development activity the agricultural value could be say £1 million and the market value can be £3 million. The additional development value of £2 million would be fully taxable to IHT at 40%, only the £1 million of agricultural value would receive IHT relief. In order to qualify for IHT relief on the hope value the land would have to be a trade.

It is often much more convenient for the farmer to just simply let the land as an investment. The letting of agricultural land can be through a farm business tenancy (FBT) which enjoys 100% APR. However, land could be let through an Agricultural Holdings Act (AHA) Tenancy (where there is more security for the tenant) where only 50% APR would be available.

Let property within a mixed estate

The fairly recent court case of Balfour, where the courts ruled in favour of the taxpayer’s claim for IHT relief, showed that where a mixed estate includes let property IHT relief can be achieved. The let property must be part of the business, ie, it is included in the business accounts, it is managed under the same structure and then BPR can be obtained on the let property. This case followed on from Farmer where IHT relief through BPR was achieved on over 20 let cottages that formed part of a mixed estate.

In order to achieve IHT relief the investment business has to be ancillary to the main trading business. The question of the investment activity being ancillary is established through a number of tests, mainly turnover, profit, hours worked and value of the property. In an ideal situation, the farming trade is the dominant activity with regard to each of these criteria.

The point in both Balfour and Farmer was that let property was historically integrated into the original farm. In the case of Farmer the let property had originally been barns for livestock, farm workers cottages, and the portfolio of let property had arisen through diversifying away from farming through necessity, i.e. the decline in farming, the decline of the need for a workforce as opposed to contractors, machinery taking over from the workforce etc. This is a clear example of how let property can achieve 100% IHT relief.

Passing to the next generation

If the property owner no longer needs the income, then they may consider giving the property away to the next generation. If they survive seven years then the property is no longer part of their estate and is free of IHT.  However, capital gains tax (CGT) is often chargeable on such a gift and advice must be sought. “Skipping a generation” can often be achieved in this scenario by gifting to grandchildren, so that they have income and their personal allowance can be used. If the children are minors then some form of trust structure should be considered.

Such a transfer is known as a ’potentially exempt transfer ‘or PET for IHT purposes – transferring to the next generation and hoping that the transferor survives seven years.

Final word:

There are instances where let property does qualify for IHT relief and given the large sums involved it is worthwhile reviewing and carefully considering the IHT reliefs and tax cases mentioned above. Planning ahead for IHT is much easier pre-death than taking the risk and letting your executors argue a case post death.

Author Neil Roberts.

If you would like to discuss in more detail anything raised in this article, or would like to have a chat about your own personal circumstances, please contact one of our specialist tax team at your local office – click here for details of our offices.

Technical content correct at time of publishing.