Capital tax planning on development land disposals
CGT & IHT impact on proceeds from land
The value of all land has increased substantially in recent years with average land values for undeveloped land now standing at up to £10000 per acre. If planning permission for development is obtained, the value of the land in question will increase considerably. This is a potential high return for land owners but the proceeds of sale can be eaten into once the effects of capital gains tax (CGT) and potential inheritance tax (IHT) are taken into account.
For example, George is a farmer; 15 acres of his land have recently been granted planning permission for residential development. George inherited the land from his father in the early 1990s when the agreed probate value was £30,000 for the entire 15 acres. On a sale to developers, George receives £4,125,000 of which £4,095,000 is subject to capital gains tax leading to a bill of up to £819,000. The net proceeds received by George no longer benefit from any agricultural property relief and are subject to a potential IHT bill of 40%. George’s children therefore stand to inherit less than half of the proceeds once all tax has been paid.
What can George do to reduce his tax bill?
The most important action that George can take is to obtain professional advice at the earliest opportunity, long before an application for planning is made, so suitable tax mitigation strategies can be put in place.
Assuming he did that, here are some strategies that George might like to consider:
George and his wife could consider using any existing pension funds they hold to buy some of the land. Pension contributions could also be made from the farming business for George’s sons who are employed on the farm, thus enabling the sons’ pension funds to buy a share in the land also. Pension funds have the advantage that they do not pay CGT on disposals, and therefore when the land is sold to the developers with the benefit of planning permission, the share of the proceeds owned by the pension funds is CGT free.
Advantages
As George is aged over 55, he can draw 25% of the pension fund as a tax free lump sum immediately, and the rest as income drawdown over a period of years. The remaining pension fund can be passed on IHT free to the next generation in due course. George’s sons will be able to draw on their pension funds when they reach the qualifying age (currently 55) so George has protected some of the land’s proceeds against capital gains tax while at the same time providing for his sons’ later years. He also has the comfort of knowing that the pension funds cannot be accessed until later life which provides an element of protection.
This strategy has certain constraints as the amount that an individual can hold in a pension without a tax charge is subject to a lifetime allowance (currently £1,073,200, although for schemes with older members it is sometimes more). Also, the amount of any pension contributions on behalf of George’s sons in any one tax year is limited. It is also important to take advice from a pension specialist to ensure that existing pension funds can be used in this way.
Nevertheless this strategy could potentially protect in excess of £1 million from capital taxation so substantially increasing the proceeds available for the family’s benefit.
Trusts
George and his wife could set up discretionary trusts into which land could be transferred. No IHT will be due on the transfer if the value of the land (after deducting agricultural property relief) is less than £650,000. Any CGT due could be deferred until the land is sold to the developers; CGT would be payable by the trustees only when the land was sold.
The land in the trust would not be subject to IHT on George’s death or on his wife’s death if they survived the transfer by seven years, but even if they did not survive for that length of time, any increase in value in the land while held in the trust would escape IHT. An IHT charge would potentially be payable when capital leaves the trust, and on the ten year anniversary of the trust’s creation, but this is at a current maximum rate of 6%. A valuation of £12,000 per acre should enable as much land as George wishes to pass to the next generation to be transferred to the trust. Again the trust provides a protective mechanism and enables George to benefit all his wider family and retain flexibility.
It would be quite common for George to decide on a mixture of strategies to provide the maximum possible benefit to himself and his family.
The sale of the land would be a major change of circumstances for George and his family and all the family would require updated Wills to reflect this. If George continues to farm then a review of the applicability of agricultural property relief and business relief would also be advisable to ensure that the maximum use is being made of those reliefs.