Fields of gold

“Buy land, they’re not making it any more” was the advice given by Mark Twain well over a hundred years ago. In the intervening period, land has performed as well as, if not better than, almost all other asset classes and, in recent years, farmland has held its value far better than many expected.

Savills’ Agricultural Land Market Survey 2011 shows year-on-year growth in farmland value since 2003 and an increase of 11.7 per cent in the average value of grade three arable land in England during 2010. It also shows that, over a 15-year period, let land has outperformed all other investment asset classes except residential property, often with considerably less volatility.

The figures produced by Savills are necessarily averaged across the country and mask some exceptional performance in some areas. While the average value of land in England reached £5,700 per acre in 2010, in some areas there were values well in excess of £10,000. For those who bought land in 2000 when the average price was at £2,000 per acre, this represents a very impressive ten yearly capital return.

Hot and cold

As with any investment, the capital return is only one element, and those actively involved in farming will have seen incomes fluctuate in recent years. While wheat prices remain close to, or above, historical highs, yields have been hit by variable weather conditions; at the time of writing the 2011 harvest has been collected in, and anecdotal evidence suggests that in some areas yields could be down by as much as 50 per cent this year.

Finally, it is worth noting that the inheritance tax benefits of owning agricultural land now extend to land within the European Economic Area, and so the possibilities for acquiring farmland as a tax-efficient investment are now somewhat greater.

There are various options available to new investors in farmland (see box) and inevitably some potential investment problems exist. These include:?

Supply. Mark Twain was right that no more land is being made and therefore the supply of land is limited. Finding the right piece of land, at the right time and for the right price is difficult. Savills notes that the number of investment buyers of agricultural land doubled in 2010 and now represents some 31 per cent of all purchasers, so the market is competitive. For the serious investor, engaging a good agent to keep an eye on a market which often moves quickly can be invaluable.

Capital investment required. ?For investors looking to farm ?land themselves, there is a significant capital outlay required to begin operating. Starting a farming operation from scratch would be a very expensive way to begin, and even purchasing plant and equipment (let alone knowhow ?and expertise) would be a huge ?cost. For this reason, it is unlikely ?that first-time investors in the agricultural market will look to ?farm the land themselves.

Liquidity. Despite the short supply of land, it is not always easy to sell quickly in case of an urgent need to liquidate the investment; farmland should be viewed only as a long-term investment and not as a source of readily available cash in times of need. Having said that, it might be easier to borrow against farmland than against some other asset classes, so raising future finance might not be as much of a problem as a full-scale sale.?

Nonetheless, for investors who are looking to make a quick turn on their investment, farmland is probably not ?for them.

Tax breaks

What are the capital tax benefits of investing in farmland? An investment which is held at the date of a chargeable event can attract relief from IHT, and this is one of the main advantages. Agricultural property relief (APR) is available at the rate of either 50 per cent or 100 per cent of the ‘agricultural value’ of the land, depending on how it is owned.

It is worth giving a word of warning for those hoping to secure relief for the long term. The Office of Tax Simplification recommended in its report of 3 March 2011 that APR and all other IHT reliefs should be reviewed in the context of an overall review of IHT. A future reduction in the relief or possibly its abolition cannot be ruled out.

In order to qualify for the relief, the land (and buildings) in question must be ‘agricultural property’ within the scope of section 115 of the Inheritance Tax Act (IHTA) 1984. The IHT legislation does not define ‘agriculture’, and it should be noted in particular that fishing or other sporting rights are not ‘agricultural’.

Agricultural land occupied by the investor for the purposes of agriculture will qualify for relief after two years of ownership. This covers land farmed in-hand by the investor or farmed under a contract farming arrangement. Agricultural land which is occupied by someone else for the purposes of agriculture (i.e. let land) will qualify after seven years of ownership.

Once the period of ownership has been satisfied, the only question is as to what rate of relief applies. The 100 per cent rate of relief will apply to all agricultural land unless it is subject to a tenancy created before 1 September 1995. Even if there is such a tenancy, the 100 per cent rate will apply if the tenancy gave the right to vacant possession within 24 months (extra statutory concession F17).

Gaining ground

So, in the case of in-hand farms and all new tenancies, including succession tenancies, the rate of relief will be 100 per cent. Importantly, however, the relief is restricted to the ‘agricultural value’ of the land (section 115(3) IHTA 1984), which means that hope or development value and mineral value will not qualify for the relief, and HMRC is known to look specifically at cases where the property purchased would attract ‘lifestyle’ purchasers who might pay a premium in excess of that which a working farmer might pay.

Ordinarily, capital gains tax (CGT) is chargeable on the disposal of agricultural property. However, where there is a disposal which falls within section 165(5) of the Taxation of Chargeable Gains Act 1992 (broadly where agricultural property which is not a ‘business’ is disposed of) then hold-over relief may be claimed. Of course, hold over is merely a tax deferral mechanism, and there may be better ways to achieve relief from CGT.

So what tax planning is available? The availability of 100 per cent relief from IHT, and the ability to hold over capital gains, makes agricultural property a very flexible investment from a tax-planning point of view. A lifetime gift is one example of a simple planning idea. Once the ownership criteria have been satisfied for APR to become available, agricultural property can be transferred between individuals or into trust. So, a flexible discretionary trust can be created into which the agricultural property is transferred (with hold-over relief claimed from CGT) and then held for future generations without any capital taxes becoming payable. Care must be taken, when considering lifetime gifts, to take into account the possibility of claw back of the relief under sections 124A and 124B IHTA 1984.

However, while hold-over relief is helpful, it does only defer CGT. So an alternative might be to transfer agricultural property to an elderly relative so that the capital gains tax uplift on death can be obtained. This can be risky, as if APR is abolished, or if the elderly relative does not satisfy the ownership criteria, the value could be held in the estate of the elderly relative. Perhaps instead the elderly relative could be given a revocable life interest in the discretionary trust mentioned above?

End result

Planning with wills is another tax planning option. It is possible with careful planning to recycle the APR available on death, so that it can be ?used on both deaths of a married ?couple. Suppose H dies, leaving his ?fully relievable assets on flexible discretionary trusts and his remaining, non-relievable, assets on life-interest trusts for W. There is no IHT on his death by virtue of 100 per cent APR ?on the discretionary trust and the spouse exemption on the life-interest trust. ?The trustees of the two trusts then exchange assets of equal value between the trusts so that the relievable assets ?are then subject to the life-interest trust, and the non-relievable assets are held in discretionary trusts. Care needs to be taken not to trigger a stamp duty land-tax liability, but, on W’s death, the relievable assets again attract 100 per ?cent APR and fall into the discretionary trust or pass to the next generation ?free of tax.

The possibilities for tax planning with farmland, in addition to its continuing strong value and potential ?for returns, make it an attractive asset class for private clients. The introduction of yet more investors into the market may serve to push values even higher into 2012 and beyond.

Chris Belcher is a partner and head of landed estates at Mills & Reeve LLP