You need to consider all available tax tools when selling land to a neighbour or family member.
These tools include the lifetime capital gains exemption, family farm roll-over rules, replacement property and capital gain reserves.
A capital gain reserve is a useful tool that producers sometimes overlook.
It allows you to defer taxes on capital gains over time and have the potential of increased tax savings.
A reserve can be used to reduce or avoid Old Age Security claw-back, take advantage of lower tax brackets and reduce or avoid potential alternative minimum tax.
You can claim a reserve when you receive proceeds for a sale over a longer period of time.
If you sell to an unrelated neighbour, you can spread out the taxable income up to five years if the payments are spread out over five years.
This could be increased to 10 years if you sell to one of your children or grandchildren.
Let’s consider the situation where John would like to buy a quarter section of land from his grandfather, Bob. They agree to a price of $500,000.
Bob bought this land for $10,000 in 1972, his current annual income is $25,000, which will continue into the future, he has used all of his lifetime capital gains exemption and he is currently collecting OAS.
John cannot get financing at a bank, so he would like to convince Bob to allow him to buy the land over time with $50,000 payments per year over the next 10 years.
There would be tax consequences if John was able to pay his grandfather $500,000 in one lump sum payment. Bob would have a taxable capital gain of $245,000 and have to pay tax on that. Furthermore, all of Bob’s OAS for that year would be clawed back when he filed his taxes. Also, he would get reduced OAS payments the following tax year.
Compare this to Bob collecting payments over 10 years and claiming a reserve on this amount.
In this case, Bob would need to recognize only $24,500 as a taxable gain each year. The tax rate on which he would pay tax each year would be less than if he sold it all at once.
Furthermore, Bob would stay below the point of OAS claw-back ($74,789 in 2017).
This makes the sale over 10 years look much more appealing to Bob.
Now let’s consider a scenario where Bob did not need any cash on the sale, but he wanted to retain some control and increase the cost base of the land to lower John’s tax burden in the future.
This would be the perfect scenario to use a promissory note.
Bob and John could structure a promissory note that would be due 30 days after demand, so Bob could still use the reserve as described above and be able to call this note if needed. Bob would have to consider how to deal with this note on his death.
Consult with a tax professional when considering what tools to use to sell your land.
Riley Honess and Bailey Hughson of KPMG contributed to this article.
Colin Miller is a chartered accountant and partner with KPMG’s tax practice in Lethbridge. Contact: firstname.lastname@example.org.