One of the biggest considerations regarding your family farm is how to transfer farm land to your children or grandchildren.
As you near retirement, the farm’s assets may be your main source of income and it is important to look closely at the options available to ensure you do not jeopardize your future security when transferring the land to the next generation.
One option to consider is to sell the land to your child at its fair market value.
When land is sold at fair market value there will be a capital gain, which is the difference between land’s original cost and its current value.
Half of this will be subject to tax, although the capital gains deduction may be available on the sale to alleviate the tax amount.
Special rollover rules exist in the Income Tax Act when property is transferred to a child, so long as the land meets the conditions to be considered qualified farm property. The rules allow you to transfer the land at any amount between the cost and fair market value.
The amount you transfer the property at will depend partly on whether the parent has enough capital gains exemption room available to offset the gain on the land.
Individuals are entitled to a $750,000 exemption and depending on the value of the land, the sale can be structured to take place at fair market value with the full gain being offset by the parent’s exemption.
However, you must also consider the possible application of the Alternative Minimum Tax when using the capital gains exemption to reduce your tax bill.
Land received by the child at fair market value will have a higher cost base, helping reduce the child’s future capital gains liability.
Parents may want to consider selling land to their children at less than fair market value if they do not have sufficient capital gains exemption available and don’t want to realize a taxable capital gain, or if they want to give the child a break in the price.
This is considered a gift to the child.
There are considerations to keep in mind when choosing whether to transfer farmland at cost, at fair market value or something in between:
Premature death of child
What if the child dies before you and the land is left to the child’s estate? With gifted land, the parent has no claim against the estate for the value of the land.
If the land was transferred to the child at fair market value, the child’s estate will receive the land subject to the parent’s mortgage. The parents’ security will not be jeopardized because they could demand repayment.
Bankruptcy of child/claims by child’s creditors
If you take security equal to fair market value, there is protection from creditors because only the child’s equity in the property would be available to creditor claims.
Matrimonial property claim by child’s spouse
Only the equity in the land after the child buys it can be claimed by the spouse. The value of the land is protected. If gifted, the entire amount could be claimed by the spouse.
Significant increase in land value
To protect the land from being sold by the farming child, the land can be sold at fair market value to the child and security could be structured so a penalty will apply and the debt be repaid within a certain period. This penalty allows the parents to share in the land value increase.
Death of parent
When the parent dies, the debt can be forgiven through the will and the child will be able to receive the title free and clear with a tax cost equal to the original sale amount. This is applicable if transferred at fair market value.
As with all estate and succession planning transactions and agreements documenting these transactions, it is advisable to seek legal and tax advice from professional advisers to make an informed decision and ensure all the steps have been taken to accomplish what you intend.
Colin Miller is a chartered accountant and senior manager in KPMG’s tax practice in Lethbridge. Contact: email@example.com.