Given the significant increases in land and quota values over the last number of years it is becoming increasingly difficult to transfer the family farm at fair market value and meet the cash requirements of paying farm debt, repaying of the parents’ investment, paying income tax on the farm operations, investing in additional farm operations and upgrades, and provide a living for the children. This tax-deferred rollover can be an invaluable tool in succession planning to enable future generations to continue working and investing in the business while providing a living for their families without being heavily indebted.
There are several important considerations that need to be taken into account when transitioning the family farm to the next generation. These items include (but are not limited to) determining the value of the farm, retirement planning for the transferor, strategic business planning, transition of key employees, treatment of non-farming versus farming children, and the overall tax considerations.
Farmers and fishermen have unique tax treatment under the Income Tax Act (the “Act”) of Canada in comparison to other business owners. They can transfer the business during their lifetime or on their death to Canadian resident children, grandchildren, step children, or children-in-law at any value between the cost and the fair market value provided the rules under the Act are met at the time of transfer. Based on these rules and provided there are future generations that want to continue the business, it is possible to indefinitely defer the tax liability on the farm property, farm partnership or farm corporation. The child effectively steps into the parents’ place as owner of the farm and inherits the parents’ tax cost. No capital gain, recapture of depreciation or any other income event will occur, which means no tax is payable until the farm business is sold to someone outside of the family.
If the transfer takes place at a price above cost, (but less than fair market value) the capital gains exemption can be utilized up to a maximum lifetime amount of $750,000 per transferor. This exemption is available on real property and eligible capital property (e.g. farm land and quota) if the farm is in the form of a proprietorship. It is also available on farm partnership interests and on shares of a farm corporation. In order to use the capital gains exemption you must meet specific rules that are outlined in the Act. Non-farm assets within a partnership or corporation can cause problems when trying to utilize the capital gains exemption on the transfer.
In BC, $750,000 of capital gains exemption results in combined federal and provincial tax savings of $164,000 (the tax savings in other provinces will differ). In a farm situation, these tax savings can be quickly multiplied as there is often more than one family member that is an owner in the business. Alternatively, the business can be structured to bring in family members as owners so that their exemption can be utilized on a transfer or sale in the future.
When using the capital gains exemption beware of other income tax and social benefits implications such as alternative minimum tax, old age security clawback if the transferor is over 65, loss of GST personal credit, reduction in provincial medical premium assistance, and potential loss of the guaranteed income supplement. There may be an ability to claim a capital gain reserve over a period of up to 10 years to mitigate or eliminate some of these issues.
Other issues to consider before transferring the farm include provincial Property Transfer Tax, GST/HST implications, and Agri Stability and Agri Investment programs.
If you are considering a transition of the farm business, please consult your local MNP advisor or contact me and we would be happy to assist you with the transition.