When a child takes over the family farm, it can often fill a parent with pride.
The farming industry is fortunate to have specific tax laws in place that allow for such a transfer to occur tax free, unlike selling other business types.
The value of farmland has risen significantly and as a result so has the potential for large tax bills if that property is sold. But the tax exposure can be reduced if the property is sold or transferred to a child.
The term ‘child’ for purposes of family farm sales and transfers is applicable in a number of situations.
Other than your biological child, it can also include an adopted child, spouse’s child, grandchild, or great-grandchild, or a spouse of any of these qualifying transferees.
Those who are considering selling or transferring farm property to a family member, should consult a professional to confirm whether or not the buyer would qualify as a child for tax purposes.
When qualifying farmland is sold to a child, it can be priced at any value between the cost and fair market value.
This flexibility allows the parent to decide how much of a gain they wish to report for tax purposes.
This gain may qualify for the lifetime capital gains exemption of up to $800,000 and as a result the parent may pay little to no tax on the sale.
The flexibility over sale price allows parents to decide how much they want or need as compensation and provides the opportunity to offer the child a chance to acquire the property sooner than they would have otherwise been able to afford.
If parents don’t want compensation from the sale, they also can transfer the property to a child at the price they originally paid for it with no tax consequences.
If the child later sells the property, the increase in value of the property compared to the parents’ cost would then be recorded as income by the child and taxes would be owed at that point.
But be aware that if the child sells the land within three years of acquiring it from the parents, there can be undesirable tax consequences for the parents.
Only qualified farm property owned by the parent can be transferred or sold to a child on a tax-deferred basis. Qualifying property includes items such as land, equipment, buildings and eligible capital property such as dairy quotas.
Items such as livestock or grain inventories do not meet the test and so additional consideration may be needed to deal with these items.
The sale or transfer of property to a child is tax free, but it may result in a higher than normal income level for the parent selling the property.
Proper planning is needed to ensure that this higher income does not have negative effects on government income support programs that are based on net income.
Old Age Security payments provide an example, where the size of those payments can be reduced or lost if the parents’ income rises too much.
Another consideration is alternative minimum tax.
This may apply when using your capital gain exemption because there might be AMT to pay even though there may be no income tax.
Knowing the options available can ease the transfer to the next generation, and reduce taxes that would otherwise have been owed. Planning is imperative, so seek advice from a expert before proceeding.