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Buying a hobby farm

Make hay whilst the sun shines.

Increasingly more people are considering purchasing farmland or a farm and property prices in this sector have shown consistent growth in recent years. This is against a backdrop of generally flat or falling prices for residential and commercial property.

Investors in land or hobby farms may hold this asset class for a number of reasons. It may be a decision to move the family to a rural environment, for better schooling and quality of life. Alternatively, the investor may wish to diversify his investment portfolio, adding rental income or farming profits to his income stream. Further, he or she may view the potential returns in the long-term from farmland as better than investing in the stock market or a business.

Additionally there can be significant tax advantages in owning agricultural land or a hobby farm. The investor may have in mind acquiring an asset class that has historically been extended tax breaks, or looking at long-term planning to protect his assets from the ravages of Inheritance Tax (IHT) after death. Increasingly we see people looking to structure their portfolios to include assets that benefit from IHT relief, whether as business or agricultural.

Agricultural property can in many cases benefit from 100% relief from IHT. Relief extends not only to the land itself, but also to certain buildings. Agricultural is a relatively wide definition and includes land, pasture and buildings used in the rearing of livestock. Thereby using the land to breed or rear sheep, cows, pigs etc, will generally mean the land qualifies for relief. Breeding and rearing horses on a stud farm also counts, but, crucially, simply stabling and keeping horses does not. This final category can often catch out the hobby farmer who wishes paddocks near the house to stable his or his children's horses.

The farmhouse itself, whilst a building used in connection with the farming business, is often critically analysed by HMRC as to whether IHT relief is available. These can often be viewed as rather grand when compared with the tatty run-down farmhouses that are often attached to working farms. Relocated from a city environment, the lifestyle farmer's house is often renovated to a very high standard and may very well be valuable in its own right. HMRC may disallow relief on such elegant and finely restored farmhouses in its entirety, and recent case law has adopted that approach for a manor house that was not deemed to be the centre of operations of the farming enterprise. Alternatively part of the value only may qualify. As might be expected HMRC are experts in this area but there are some key factors that can assist to obtain that valuable relief from tax and it is essential to show that you, and the farmhouse, are intimately connected with the business of farming.

Some new owners of rural land would rather let the land to, for example, a neighbouring farmer, perhaps taking the view that rural land is an asset class in which he or she wishes to be invested, rather than being personally involved with the farming operations. In these cases it is important to ensure that the terms of that letting are a special type of lease that qualifies for IHT relief. Crucially here, unlike the active farmer, the land then only benefits from tax relief after it has been owned for seven years, rather than two years in the case of a person farming themselves (or with a manager).

It is also important to be careful where you allow others to graze your land, even for a small fee. Whilst having horses, cows or sheep within one's idyllic view from the kitchen window is attractive, the grazing arrangements need to be structured carefully so as not to prejudice the tax relief. Properties let out for non-agricultural purposes, such as leased to third parties, as well as fishing and sporting rights will never qualify as agricultural property unless they are part of a wider enterprise of the business of running the 'estate' generally. This topic is too wide for this article, but one currently on the IHT radar and where there is significant potential for saving tax on a wider class of rural assets than just the land or farm itself.

As well as IHT, there are other tax advantages of holding rural land and hobby farms. For Capital Gains Tax (CGT), on a sale, if the owner was actively involved in the business, the tax on the land can be reduced from 28% to 10% if appropriately structured. It is also possible to give the assets away to one's children, for example, deferring the capital gains tax until the subsequent sale to a third party. Roll-over relief is also available in certain situations, to enable one type of asset to be sold and the proceeds re-invested in an alternative or replacement business.

Income tax can also be minimised if the business is run so that losses can usually be offset against profits from other elements of one's portfolio and income. There can also be VAT savings to be had. These areas can be complex so it is essential that appropriate legal advice is taken.

It is essential to consider all of the practical and financial consequences before investing in rural land or a hobby farm. Many people are unaware that, unless structured correctly, the tax advantages offered to the rural landowner can be denied. If so, the hobby farm may be less of the rural dream than was intended.

This article first appeared on the Money Observer websiteon 14 November 2011

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