Much has been written in the press about how much the country cottage has become attractive in “lockdown” with “working at home” arrangements. Matters have been helped by the Stamp Duty Land Tax “holiday” which has been extended to 30 June and again in the period to 30 September. The exemption in the final period will be kept at £250,000 and return to £125,000 from 1 October.
Another matter that has been in the tax press has been about the residential capital gains tax (CGT) returns from 6 April 2020 together with the tax complications of farm partnership property. A feature of the OTS Report on IHT was to increase the Balfour % of trading to investments of 50% to 80%. For farmers this has resulted in the need to consider reducing investments from the farm operation so as to focus on the “trading” element under s105(3) to ensure that the overall operation to not be “holding investments” as the main core. The OTS suggestion to change the Balfour % was not included in the 2021 Budget nor in the “Tax Day” but it has still served to highlight that most farms have too many investments such as rental cottages.
Confused ownership of farm cottages
When it comes to selling cottages, many cottages have confused ownership, e.g. farm partnership cottages can have muddled details of ownership and unrecorded details of improvements together with uncertain CGT reliefs such as principal private residence (PPR) relief. It could be, for example, that the cottage was left by the parents to the three farming partners before 1982. Two of the partners have lived there and paid for improvements. The capital gain will have to be split between the brothers as CGT is an individual liability, but the CGT base cost for each partner could be very complicated.
Improvements to cottages
Enhancement expenditure paid by one partner can be added to the cottage’s base cost. Therefore, any added value of, for example, a new kitchen, bathroom and central heating which have been contributed can be added to the base cost relating to that partners share of the gain. In practice, it could be applied to the shares equally if the records are good enough. The split between the farming partners and the tax allowability does have to be considered carefully by the tax advisers and the farm accountants.
The starting position is to try and sort the CGT base cost of the cottage before the sale is decided upon and it should be understood whose money was used for the work (private or the partnership’s) and in whose name it was carried out. Likewise, if there were any agreement/loan between the partners that one would pay for the works on the house they were living in, in return for occupation, then this should be sorted out. One focus of this article is to show that this type of agreement between the partners should be included with the drafting of the Partnership Agreement. Another key point is how the partners actually share the proceeds of the eventual sale.
Individual partners paying for work to cottages
If improvements were carried out in individual names and with the individual partners own money, the default position would be that their expenditure would only go against the individual partners portion of the gain in the percentage of the gain. However, it might be arguable to spread the total combined expenditure across all the partners’ shares if they were partners in the business, which might be more beneficial to some of the partners who have fewer years with the property as your PPR. Ideally such expenditure is recorded correctly in the partnership accounts with a trail to show how the proceeds should be divided. If, for example, in a partnership of three partners, partner A has spent money on Daisy Cottage and this is included in his partners capital account, then the partnership has effectively paid for the improvements. Then each of the partners A, B and C can claim the expenses. However, if partner A paid for the improvements themselves and these were not included in the partnership accounts then partner A can include these costs in their individual tax return. CGT is an individual not a partnership liability but the partnership must agree methodology, particularly for the proceeds.
Partnership improvements to the cottage can be added to the base cost of the cottage for all the partners. This helps highlight the need to have a Partnership Agreement or partnership minutes that clarify such matters and expenditure.
Another concern for the tax adviser is whether there’s the possibility of rolling over any remaining gain by the partners on the cottage not covered by PPR into future purchases/developments. If the cottage was occupied by a farm worker as a farm workers cottage then rollover could be allowable on the business asset. If the farmhouse is occupied as a farmhouse by the farming business and used as a business asset, then rollover relief could be available. Documentation of the need for partners to stay in the residence can again be in the Partnership Agreement.
For rollover purposes it could be sale proceeds are to be used to improve the farm trading assets. Where, for example, the cottage proceeds are used to convert farm buildings into more residential properties to be let out then no rollover will be allowed. There is also a risk of increasing the investment activities which is a problem under the OTS Report on IHT. Rollover into improvements to farm trading assets would be positive for tax relief.
Whilst the OTS Report on IHT and CGT has not yet been put into legislation and whilst future Budgets are awaited, farm cottages will still be sold, and tax advisers must encourage farm partners to ensure that all farm base costs are ascertained. With the “Agricultural Transition Plan” evolving from the Agriculture Act, the drop in area-based subsidies and a real worry about the future profitability of the farming operation this could lead to more farms generally coming on to the market, it is essential to ensure that all farm base costs are available to carry out the calculation of future liabilities. Likewise, where farm sales are considered as an alternative tax planning route, the potential CGT liabilities must be available.
Lifetime transfers of farms have come very much under the spotlight with the Budget and “Tax Day” not attempting reform of either IHT or CGT. This is generally under the principle of passing to the next generations whilst the tax reliefs are so positive. Therefore, many tax advisers promote considering passing farms to the next generation. There is much debate on whether let agricultural cottages can be eligible for holdover relief under TCGA 1992, s 165 so that they can be passed down to the next generation without a CGT liability. Let cottages with farmland can qualify for holdover relief. The land qualifies for agricultural property relief and as long as there is some amount of this relief on the asset gifted, all the asset transferred achieves holdover relief without any apportionment. This is the effect of TCGA 1992, Sch 7 Pt 1, paras 1 and 2.
Many advisers are sceptical about this and the lack of the application of the apportionment rules because it confers entitlement to holdover relief on an asset that does not itself qualify as business property and is part of let property – an investment asset. The benefit here is the agricultural property qualification of the land. Tax advisers have used this legislation for clients who have gifted a cottage (let on an assured shorthold tenancy) at the same time as, say, 20 acres of agricultural land and it is possible to claim holdover relief in full for CGT purposes. The claims our firm have submitted have not been challenged by HMRC. The reason for allowability is because if a transfer is of an asset or part of an asset where relief is due because of the agricultural property extension (this refers to TCGA 1992, Sch 7, para 1) then no reduction is made for non-trade use etc. under the apportionment rules, which are contained in Sch 7 Pt 2 para 6. The combination is let agricultural property.
With the tax adviser’s worries over how long inheritance tax agricultural property relief etc. and the favourable CGT rates will remain, there are many farmers wanting to take advantage of the current position before it disappears. This also applies to many agricultural tax reliefs which will ensure that farm tax advisers will be very busy in the months ahead.
Julie Butler F.C.A. is the author of Tax Planning for Farm and Land Diversification (Bloomsbury Professional), Equine Tax Planning ISBN: 0406966540, Butler’s Equine Tax Planning (2nd Edition) (Law Brief Publishing) and Stanley: Taxation of Farmers and Landowners (LexisNexis), and editor of Farm Tax Brief.*The views expressed are the author's and not ICAEW's.