Farmers are very well treated by the IHT rules and farming is the only type of business where the proprietor can claim an exemption from IHT on their home. However, farmers are notoriously poor at keeping records and there are a number of pitfalls which need to be avoided if the farm is to be passed smoothly down to the next generation without adverse IHT or CGT consequences.
Turning to the farmhouse first, there are 2 conditions that must be satisfied if the farmhouse is to be eligible for 100% Agricultural Property Relief (APR):
1. It must be ‘occupied for agricultural purposes’ ie one or more individuals who are involved in the faming business must live there eg a sole trader or 1 or more of the partners in a farming partnership
2. It must be ‘of a character appropriate’ to the land being farmed ie in broad terms, the bigger the farmhouse, the more land that must be farmed with it
The golden rule to avoid falling foul of the first test is that a farmer should never retire no matter what age he is. The simple reason for this is that if, for example, an elderly famer is still living in the farmhouse, if he retires, the farmhouse will no longer be ‘occupied for agricultural purposes’ and will therefore be fully exposed to IHT at 40%. Please note that farmers will not generally qualify for the new Residence Nil Rate Band (RNRB) – see separate article – since the high value of agricultural land usually means that the value of their assets exceeds the £2 million limit. In any event the RNRB will be capped at £350,000 from 6 April 2020 and farmhouses are often worth considerably more than that.
If we take, for example, the not uncommon case of a father and son where, over time as Dasd gets more frail, the son has taken over responsibility for the bulk of the farming operation, there is no reason why the 2 of them should not farm in partnership with the son taking a larger profit share. The key thing is that the father should remain as a partner, perhaps with a 10% or 15% profit share, thereby ensuring that the farmhouse remains eligible for 100% APR. Of course, if the son was also living in the farmhouse with his father then the farmhouse would then be being ‘occupied for agricultural purposes’, regardless of the status of the father. However, where, as is common, the father retains an interest in some or all of the land being farmed, there may be other good reasons (see further below) why he should remain as a partner until he dies.
Turning to the bare land itself, generally whether the land is being farmed by the owner or another person, the land will qualify for 100% APR. If the land is being farmed in hand, then a minimum 2 year ownership period is required in order to claim APR although where the land has been inherited from a spouse, the spouse’s period of ownership can be included. Where the land is being farmed by a third party, 100% APR can generally be claimed, subject to a minimum ownership period of 7 years. Accordingly where the land is tenanted, provided it has been owned for 7 years, 100% APR can be claimed except where it is subject to an old-style Agricultural Holdings Act tenancy entered into before 1 September 1995 where there is no right to vacant possession within 2 years, in which case only 50% APR is available. Please note, however, that in the latter case, such a tenancy can be converted into a post 1 September 1995 tenancy qualifying for 100% APR, although great care must be taken to avoid triggering adverse CGT charges on the surrender of the old tenancy.
It is also important to note that, where land has been let out and the landlord continues to occupy the farmhouse, the farmhouse will no longer qualify for 100% APR because it is no longer being ‘occupied for agricultural purposes’ vis it is the tenant, rather than the landlord, who is carrying on the farming business. For that reason, often elderly farmers enter into arrangements such as ‘share farming’ and ‘contract farming’ so that they can claim that they are still farming thereby preserving their entitlement to IHT and CGT reliefs. However, one can expect HMRC to scrutinise such arrangements carefully to ensure that the landowner retains responsibility for and is actually carrying out acts of husbandry in relation to the land. If a farmer is proposing to enter into such an arrangement it is important that the terms of the agreement between the landlord and the ‘share’ or ‘contract’ farmer are adhered to and the Accounts reflect the obligations of the parties eg in relation to buying seed or fertiliser.
It is also important that detailed records are maintained of the landowner’s involvement in decisions affecting the farming operation and that this is not simply left to the ‘share’ or ‘contract’ farmer. This might take the form of a farm ‘diary’ and can be produced to HMRC if and when required eg after the death of the landowner.
Whether a landowner is farming or not is also important in relation to another type of IHT relief – Business Property Relief (BPR). This is because APR is only available on the agricultural value of land or buildings. If, for example, a farmer owns land or barns with potential development value, then APR will only apply to the agricultural value of such property, not the ‘hope’ value which could be very considerable if, for example, the land is likely to go for housing or barns are ripe for conversion into residential accommodation. For example, while the agricultural value will probably be in the region of £15,000 per acre, the hope value could be as much as £1 million per acre or even more. If the landowner is farming, then 100% BBR can be claimed on the hope value, whatever that value might be but, if, for example, the land is let out, then BPR will not be available. In the latter circumstances, if the landowner dies owning the land or barns with development potential, then (subject to spouse exemption which, in any case, is only likely to defer the problem to second death) IHT will be payable on the hope value at 40% which could, in an extreme case, force the farm to be sold.
Conversely, if the landowner is farming then 100% BPR can be claimed on the development value if the farmer dies and this enhanced value will be used as the ‘base cost’ for CGT purposes on any future sale of the land for development thereby minimising any CGT charge on the disposal. It should be noted that even if the landowner has no intention of developing the land or selling it for development, this will not stop HMRC from valuing any ‘hope value’ or assessing it to IHT on his death.
Accordingly, it is very important that all farmers know exactly who owns any farmhouses, land and farm buildings and understands whether, and to what extent, any real property will qualify for APR or BPR. Steve Meredith who recently joined us has specialised in agricultural work and advising farmers about succession planning and Wills for some 20 years and is very experienced in balancing family needs against tax considerations so that farmers get the best of both worlds.
For a free consultation please contact Steve at SMeredith@horsey lightly.com or on 01685 580858.