Every farm B2B business directory, whether a sole proprietorship, partnership or corporation, will some day change ownership. This Factsheet deals with the tax implications of transferring farm assets to family members and the options available to minimize tax.
Prior to any major transfer of assets it is critical to consult a tax advisor. Do this well in advance, since the best tax results often require a two or three year planning window.
For information on the sale of farm assets outside the family see OMAFRA Factsheet Taxation on the Sale of Farm Assets, Order No. 08-047. For an overview of the succession planning process refer to the Farm Succession Planning Guide, Publication 70.
A change in farm ownership is often a significant transition, with two significant components. One is the “procedural” dimension dealing with the how, when and what to transfer. This could include tax implications, credit arrangements, business organization, operating agreements, insurance, wills and legal documentation.
The second is the “psychological” dimension. This involves the family and relationship dynamics that often determine the ultimate success of a family farm business transfer. Components include the meshing of personal and business goals, the willingness to let go of ownership, the selection and training of a successor(s) and communication among family members.
Transition Manager and Team Work
A farm transfer and succession plan can be complex. Given the multitude of components an advisory team is essential. A business management advisor can help the family:
* clarify goals
* identify alternatives
* assist with business and financial planning
* understand the potential tax and legal ramifications
The accounting and legal advisors can fine tune the alternatives and implement the decisions made by the family.
The most successful farm business transfers usually reveal a strong transition manager who acts like a team captain. Ideally the farm business owner would fill this role, providing the leadership, attitude and patience needed for a successful transition.
Important Considerations
Clarifying Goals
Before formulating any meaningful transfer plans, it is crucial to clearly identify family and business goals and communicate these to all farm family members. Some farm families find this easy, others benefit from professional advice. A current business advisor may be able to help with this step or direct you to another professional.
Farm Business Viability
Since the B2B business directory must be profitable – or have profit potential – for a farm transfer to occur, determine the financial condition of the business early in the transfer planning process.
Financial Needs of Parents
If parents have other assets or sources of income they could be more generous in both a transfer price and credit terms. However, this would not be the case if the parents have considerable cash needs.
Successor Training
A successful farm business transition is more likely where the successor(s) have management experience. This is often obtained through owning assets, revenue-sharing arrangements, or where progressive management responsibility is given over time.
Section 2 – Methods of Transferring Farm Business Assets
There are several methods of transferring farm business assets.
1. Bequest
Farming and other assets can be transferred by bequest through an individual’s will. If certain criteria are met, most farm assets can transfer from parent to child upon death free of immediate tax. In the absence of a transfer plan the will can be a “contingency” plan. Unfortunately some families use the will as their primary transfer vehicle, creating uncertainty for the farming children. It also prevents farming children from developing their own succession plans with their children.
2. Gifts1
While farming children would prefer this method, not all farmers can afford to make such a gift. Many farmers do partially gift their farms by selling to their children at below fair market value or by gifting certain assets. In either case there is no tax on a gift of farming assets. The gift of a non-farming asset to a child however may be taxable. Placing a child on title to a property is also a considered a gift to the child and a disposition or transfer of the property for the parent.
One exception is the gifting of inventory, which is fully taxable in the year it is transferred.
Gifts to minor children or spouses can result in property income from the asset being attributed back to the giver. These rules are covered in Section
3. Sale
The sale of farm assets to family members at fair market value (FMV) is the same as selling to a non-family member. Normal tax calculations are made. Good planning is essential to create the desired tax results.
4. Combination – Bequest, Gift, Sale
Most transfers involve a combination of bequest, gift and sale. Parents often desire to sell farm assets at the lowest price they can afford in order to defer the maximum amount of tax. A bequest can then be used to distribute other assets to non-farming children on the parents’ death.
Section 3 – Income Tax Rollovers and Deferrals
The Income Tax Act allows farmers to defer tax on the transfer of farming assets to a spouse or child. This is called a “rollover”. Spouses can also receive non-farming assets by way of rollovers. On a rollover of farming assets to a child any price between zero and fair market value can be chosen, although for tax calculation purposes the tax cost is used as the lowest value. The rollover provides significant flexibility in choosing appropriate transfer values. Even though the $750,000 capital gains exemption may be available, it is desirable to maintain the eligibility for the rollover.
The term “child” has an extended meaning and includes a daughter, son, grandchild, great grandchild, son-in-law, daughter-in-law, adopted child, step child or their spouses who are resident in Canada. In addition a person who, at any time before aged 19, was wholly dependent on the taxpayer for support and of whom the taxpayer had, at that time, in law or in fact, the custody and control is considered a child.2
Rollovers of property to a child must meet the requirements outlined below.
Requirements for Tax Deferral Rollovers from Parent to Child
To qualify for the rollover to a child the eligible property must, before the transfer, be principally used in a farming business in which the individual, their spouse, common-law partner or their child or parent, was actively involved on a regular and continuous basis.3 In 2006 the words “immediately before” were inserted into Section 70 of the Act that made the provision more difficult to meet. However Canada Revenue Agency (CRA) has indicated they intend to revert to the phrase “before the transfer”.
According to the CRA “principally used” means the property must have been farmed for more than 50 per cent of the time of ownership by the transferor. See OMAFRA Factsheet Taxation on the Sale of Farm Assets, Order No. 08-047 for a more detailed explanation of the term “principally used”.
Other Considerations
* The eligible property may be owned either solely or jointly
* The transfer may take place while the taxpayer is alive, or at the time of death
* Rollovers are allowed on successive transfers such as a rollover of property to a spouse and then to a child while alive or upon death. The assets eligible for a rollover could also pass to a spousal trust and then to a named child
* Eligible property transferred from an estate must vest indefeasibly with a child, which means it must transfer to the beneficiary within 36 months of death with no strings attached. A longer period may be granted if special circumstances warrant it
* On the death of a child an election is allowed to transfer the property to a parent on a rollover basis.4
Pitfalls that could negate rollovers
* Rental of assets to persons other than children or spouses for more than 50 per cent of the ownership period negates rollover and deferral.
* A “tainted” spousal trust can negate a rollover. This can occur if the spousal trust breaks certain rules. For example if a spousal trust makes payments to someone other than the spouse it would no longer be a valid spousal trust.
* An obvious beneficiary of a spousal trust must be named. For example, a will that leaves land to a named beneficiary if they outlive the spouse, but to a different beneficiary if the first beneficiary should pre-decease the spouse, can negate a rollover.
Section 4 – Capital Gains
Taxation of Capital Gains
Fifty per cent of a capital gain is tax free. The other half is subject to regular tax. This portion, called the taxable capital gain, is added to all other income in the year the gain occurs. Any allowable capital losses can be deducted from the taxable capital gain. If the capital gain occurs on a corporately owned asset, 50 per cent of the gain is tax free and is allocated to the Capital Dividend Account. Dividends from this account are received tax free by the shareholder. The other half of the gain is taxable in the corporation.
Some tax credits may be affected in the current year and/or the year after reporting a capital gain, even though the capital gains exemption is used. This is because the taxable capital gain is reported on your tax return and affects the calculations of tax credits even though the exemption is used to reduce the tax paid. The increased net income may result in the claw back of some benefits such as the Old Age Security and Child Tax Benefits in the current year and may also reduce them in the year following the capital gain.
$750,000 Capital Gains Exemption5
In 2007, the Capital Gains Exemption was increased to $750,000 from $500,000 for dispositions occurring after March 18, 2007. The $750,000 Capital Gains Exemption is available to individuals on the sale of qualified farm property. Anyone who used the entire $100,000 general exemption when it was eliminated in 1994 has $650,000 remaining. The exemption is also available to partners in a partnership, since capital gains in a partnership flows directly to the partners who can then use the exemption. The capital gains exemption is not available to corporations; however, the shares of a family farm corporation are eligible for the exemption.
Qualified farm property6 includes:
* farm land and buildings
* shares in a family farm corporation
* an interest in a family farm partnership
* quota
Equipment and machinery are not eligible for the capital gains exemption. However, in a partnership or corporation, the value of equipment and inventory is included in the corporate shares or partnership interest.
Qualified farm property must meet the following definitions:7
* Property must be principally used in farming by one of the following qualified users:
* the individual
* the spouse, child or parent of the individual
* or by a family farm partnership or corporation of the individual, spouse, child or parent
and
* Property purchased prior to June 18, 1987:
o must be used in principally farming in the year of sale or
o have been principally used in farming for any 5 years during its ownership
* Property purchased after June 17, 1987:
o must be owned for 24 months prior to the sale
and
* in at least two years, the gross farm revenue of one of the qualified users who is actively engaged in farming the property must exceed income from all other sources
or
* the property was principally used by a family farm partnership or corporation in a two-year period, during which time the individual, spouse, child, parent or partnership of which they are a member, was actively involved in the farming business.
In all cases, the qualifying individuals – whether farming as a sole proprietorship, a partnership or corporation – must be actively engaged in management and/or the day-to-day activities of the business.
Definition of “Principally Used”
Similar to the requirements under the rollover provision, the CRA defines “principally used” to mean “more than 50 per cent” from either a time or usage perspective.
1994 $100,000 Capital Gains Election
In 1994, the $100,000 capital gains exemption for general property was eliminated. At that time, individuals were allowed to elect to increase the adjusted cost base of their property by up to $100,000, but not exceeding the February 1994 value. If you made such an election on your qualified farm property, you are deemed to have disposed of the property and reacquired it in 1994. As a result you must now meet the more difficult post-June 17, 1987, rules for qualified farm property on a future sale.
Splitting Capital Gains Between Spouses
If both spouses contributed to the purchase of property, they can split the gains to reduce taxes. Although both may be on title, it is the contribution toward the purchase that is the most critical. Generally, the capital gains from assets that are transferred to a spouse by way of gift attribute back to the spouse who transferred the asset. However the timing of the transfer is important.
Spouses added to title on or before December 31, 1971, would likely be able to split the capital gain. However, if they were added after that date, attribution rules would prevent splitting. See Section 6 for an explanation of the spousal attribution rules.
If the property is the asset of a spousal partnership, the capital gains will flow through to each partner based on their percentage ownership.
Calculating Your Capital Gain
Adjusted Cost Base
To calculate a capital gain or loss, you must know the adjusted cost base (ACB). This is the amount deducted from the selling price to determine a capital gain or loss. For property obtained before 1972, the ACB is the greater of original cost or the December 31, 1971, value. If obtained after 1971, the ACB is the purchase price plus costs. The cost base of land is adjusted by adding any non-depreciable capital improvements, legal and realty fees to the adjusted cost base. The ACB of buildings is increased by any capital improvements or additions, beyond just the normal maintenance and repair. Table 1, Calculating Capital Gain, shows an example of a capital gain calculation.
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