Replies to Queries - 3 - Farmer's family problem

In the early 1990s, a farmer jointly owned a farm with his father. They built a retirement bungalow on the farm for the father and mother and applied for a mortgage to replace the original bank funding. The father died intestate before the mortgage was advanced, so the farmer and his wife took the mortgage out in their own names.

Although intestate, the father left a letter stating that he wished his widow to have the use of the bungalow for her lifetime. The widow and the other members of the family signed a deed releasing all the estate and their interest in the land to the farmer. The farmer and his wife continue to pay the mortgage on the bungalow, which is in their name, but is occupied rent free by the widow.

She considers that the bungalow is hers for her lifetime and wishes it to be sold and the proceeds given to her. She would then buy a smaller house and use the balance of the capital for her upkeep. This leaves the farmer and his wife without any proceeds to pay off the remaining mortgage or to pay the capital gains tax which would arise from the sale and they would find it difficult to finance these costs. The farmer does not wish to upset his mother and is looking for a solution which would at least save the capital gains charge.

(Query T16,022) - Dutiful son.

Additional factors that impinge upon the best course of action here are as follows:

Based upon the above assumptions, the following points should assist.

The two negatives are as follows. First, there is no scope for dependent relative's relief as the building of the bungalow and its occupation by the mother took place after 1988. Secondly, as it seems unlikely that the dwelling was used whilst either parent was a farm partner or employee, the sale would not qualify as a business asset for taper relief.

The positive approach focuses on the current value of the bungalow, complete with a sitting tenant who pays no rent. Furthermore, it is probably subject to an agricultural tie. These factors would combine to produce a comparatively low valuation if an open market value were to be taken as the proceeds in a capital gains tax computation. This might be achieved by transferring the ownership to the mother now, adequately in advance of any proposal for sale. As the sale would be between connected persons, section 18, Taxation of Chargeable Gains Act 1992 comes into play and market value (usefully low in this case) will be substituted for proceeds.

Actual proceeds that the mother would pay the son could therefore be determined by the family's wishes. Perhaps it could be equal to the amount of the mortgage, but with an agreement that the sum could be held as an interest-free loan by the son until an agreed later date.

By substituting a low value for the proceeds, the capital gains tax liability on the son and his wife might not be too great. The calculation would be based on the following.

The next stage would be for the mother to consider the sale of the bungalow. As it would then be hers it would be exempt from capital gains tax by virtue of it being her principal private residence. She would see a substantial uplift in its value through being able to sell it freehold. If the planning had been subject to an agricultural tie, she should also take advice on obtaining its removal. In the current poor farming economy a good case could be made, with useful precedents, that the downturn in farm profitability has led to it no longer sustaining a viable holding. If successful, a further tax-free gain in the value of the dwelling would be made.

The mother would need to leave sufficient time gap to ensure the transactions could not be deemed by the Inland Revenue as being pre-determined steps, otherwise the Ramsay principle could be invoked to substitute the higher freehold valuation for the tenanted one as the connected persons' valuation. A few months should suffice, as long as no specific steps had been taken to sell the property beforehand.

If the mother feels that she should not offer sufficient of the sale monies to clear the son's mortgage, he might at least be able to re-arrange the borrowings in a more tax efficient way. To achieve this, the combined capital account of the farm balance sheet relating to the farmer and his wife needs amply to cover the mortgage. His bank manager also needs to be co-operative, as the first step is for the bank to extend the overdraft facilities. The partners then withdraw sufficient funds from their farm bank account to build up enough money in their private accounts to enable them to repay the mortgage on the bungalow. This leaves them solely with borrowings attached to the farming business, the interest on which would all be allowable as a business expense. The amount must not exceed the partners' accumulated capital account, neither should it directly clear the mortgage in a single lump sum. At a later date part of the overdraft could be converted into a farm loan if the parties so wished.

The above techniques should help to maintain family harmony whilst leaving the son and daughter-in-law in a viable position. - AM.

This seems to be one of those situations where if the parties had known that they were going to end up in this predicament they would have started out from a different place. Under the rules of intestacy, presumably a part or all of the bungalow could have been transferred to the widow, in which case she would have had the benefit of the capital gains tax principal private residence exemption. However, the estate was dealt with rather differently, presumably following in spirit, if not to the letter, the father's intention that his widow should have the use of the property for her lifetime, with the reversion then passing to his son? One presumes from the fact that the father's interest in the farm property was transferred to the farmer that there were liabilities relating to it, which reduced its value.

Especially if the father's letter is still in existence, there could be an argument for saying that a trust is in existence of which the mother is a beneficiary with a life interest and the farmer holds the legal title to the property as trustee. He, of course, is also the remainderman. Letters have been held to be sufficient documentation to constitute a trust, although here the impact of the deed of release needs to be considered. If the trust argument could be supported, then the private residence exemption of section 225, Taxation of Chargeable Gains Act 1992 would apply. Paragraph CG37543 of the Revenue's Capital Gains Manual, referring to intestacies, states that 'If the estate includes land, then that land is settled property as a whole, and any disposal is by the trustees alone. There is support for this conclusion in the judgment of Sir John Pennycuick in Pexton v Bell and Another (Colbourne Will Trustees) and Crowe v Appleby 51 TC 487, Section I, where he says that there is a single settlement, not a double one, whereby the trustees hold the property in trust for themselves as tenants in common'. If this approach is successful, the widow's life interest in the property (the present bungalow, or its replacement property and capital) must be taken into account in calculating any inheritance tax at her death. From the need for capital, perhaps this is not a problem, but in any event the widow cannot take the money and treat it as her own. - Southern Man.

Editorial note. Other replies suggested that if the mother were, ultimately, to own a property after the sale of the bungalow, her will should bequeath this to her son. This suffers from the major defect that the will could be subject to change and any future nursing home fees could affect the residuary estate. In addition, inheritance tax implications on the mother's estate, and also the estates of the farmer and his wife on a gift to the mother, should not be overlooked. Also mentioned was the possibility of the farmer occupying the bungalow as his principal private residence for a period to obtain the benefit of partial capital gains tax exemption.

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