Farmers who own holiday cottages need to take measures to preserve Inheritance Tax (IHT) relief after a recent court ruling.

Accountants are warning farmers to ensure they protect their assets after an appeal tribunal found in favour of HMRC in a significant case where a woman owned 25% of a holiday cottage.

Nicollette Pawson co-owned a large bungalow on the Suffolk coast with her daughters. After her death, her daughters, who were executors of her will, made a claim for business property relief (BPR) from IHT. When HMRC refused the claim, Mrs Pawson’s executors took the case to a tax tribunal.

At the hearing they demonstrated services provided such as cleaning between lets, providing bed linen and maintaining the garden, claiming these showed the holiday let was a business and not just exploitation of an interest in property.

The tribunal found in favour of the executors, which was a surprise to many, according to accountant Rob Hitch, partner at Dodd & Co.

“To many observers this was a surprising decision given there was only one holiday unit and minimal services were provided,” he said.

HMRC appealed this decision and it was overturned in early 2013, bringing the value of the property into the late Mrs Pawson’s estate.

This ruling affects owners of single holiday cottages and possibly owners of several separate units. Capital gains tax reliefs are still protected, as the ruling only affects IHT.

Mr Hitch advises farmers to consider the following measures to help ensure holiday cottages are safe from IHT.

• Review wills to ensure assets not attracting BPR are dealt with promptly.

• Consider switching borrowings to holiday properties.

• Review ownership to see whether BPR can be secured in other ways.

• Keep detailed records of the work involved with running the holiday cottage.

BPR is a test of “wholly or mainly”, which means that as long as at least 50% of a business is trading – measured by turnover, profitability, asset value and management time – then businesses will attract BPR.

For many farmers however, diversified businesses such as holiday cottages have been moved outside the farm business to prevent VAT being charged on the letting income. While an option for some will be to transfer ownership to a trading business to protect BPR, the VAT cost will have to be taken into account, said Mr Hitch.

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