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IHT Relief for Let Property - When is it Possible?

Let property as an investment

Many people consider that the landlord is disadvantaged in tax terms. Those old enough to remember the investment income surcharge will recall one of the obvious disadvantages of let property for income tax – that owning let property is considered an investment.

Although investment income surcharge no longer exists, there are other disadvantages suffered by the landlord in UK tax terms, in that the owning of property is still not considered to be a trade. Property ownership is deemed to be an investment and therefore income tax losses arising from property ownership cannot be offset against total income in the way that trading losses can (there was a little quirk in the legislation concerning agricultural let land but that tax advantage was removed in the Finance Act 2012).

The future inheritance tax (IHT) bill that will be due on property that is let out is possibly something that keeps a lot of tax advisers awake at night. So what are the potential action points?

Passing to the next generation

One way to mitigate future IHT bills is to pass the let property to the next generation and hope that the transferor can survive seven years and also manage without the income. However, there is often a capital gains tax (CGT) problem associated with such a gift. “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 has to 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.

Let farmland

Let farmland actually 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 such an operation is not a trade Business Property Relief (BPR) cannot be applied to the market value should the market value exceed the agricultural value. Instantly there will be a question – what is the difference between agricultural value and market value? 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 outside a large town was owned with lots of development activity and the agricultural value is, say, £1 million and the market value is, say, £3 million, the landowner would be able to claim IHT relief on the agricultural value but not on the £2 million of development value. In order to claim relief on the hope value the land would have to be a trade.

However, in reality it is often much more convenient for the taxpayer 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 case of Balfour 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. The case of Balfour (Earl of) v HMRC [2010] UK UT 300) followed on from Farmer (Farmer’s Executors) v IRC [1999] STC (SCD) 321) where IHT relief through BPR was achieved on over 20 let cottages that formed part of the 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 (under IHTA 1984, s 105(3)) 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. There must be many tax planners who are considering buying a farm to add on to their portfolio of cottages or an investment which includes a farm with let cottages or, indeed, where a taxpayer has a pure traditional farm without let property where they actually buy let cottages around the trading activity.

The tax planning of buying let cottages might be considered fragile, as 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.

Furnished holiday let

The recent case of Pawson (Mrs N V Pawson’s Personal Representative v HMRC [2012] UK FTT 51) (which is subject to an appeal by HMRC) showed that IHT relief can be achieved on a furnished holiday let property. There are many who consider that the case of Pawson ’lowers the bar‘ with regard to criteria that are needed to show that there is a trade, e.g., the level of service, activity and involvement.

Let commercial property

Commercial property is often let with a large amount of services. For example, there can be a mix of long-term tenants and conference rooms involved. Guidance can be obtained from the IHT case of George (Stedman’s Executors) v CIR [2004] STC 147, which concerned a caravan park and services around the provision of residential caravans with swimming pools and restaurants. The George case can be used as a comparison for the degree of service.

Serviced offices can have restaurants, cafeterias, a doorman, a managed reception facility, there can be hiring out of staff, PAs etc, so that the vibrant small business has all the image and support of a fully serviced office without having to take on that strain of the cost on a full-time basis. The question is will such offices qualify for BPR? Clearly it can be argued that serviced offices are very similar to the furnished holiday let. The services provided are not just the normal services provided by a landlord as was set out in the case of McCall (McCall v IRC [2009] STC 990) but the provision of services is going further. The trade is providing serviced accommodation – the activity is not just looking after the common areas and making sure that the property is well maintained and well looked after in the role of landlord, but is providing services that go beyond that of an investment and any “intelligent businessman” (a quote from the Pawson case) would see that this is actually a trade. The letting of commercial property can be a trading activity and therefore BPR could apply. Such a view is yet to be tested through the courts.

Practical Tip :

It is hoped that the above examples clearly show that it is possibly incorrect to say that “let property does not achieve IHT relief”. There are examples where let property does and these proven cases and principles can be taken advantage of by the owners of let property. From a planning viewpoint, the principles of the IHT tax cases mentioned should be reviewed and carefully considered.

Where an investment activity does move into the criteria of a trading activity, IHT relief can be available but research, detail and evidence must be considered and this is something that should be looked at pre-death rather than post death - otherwise there is the big problem of “your best witness is dead” as it is impossible for the taxpayer to totally explain all the services that are being provided.

Julie Butler F.C.A.

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