Taxation often makes up the largest expense and accounts for the largest loss of wealth in the lives of many farm families, particularly during retirement years, says Donavon Tofin, a tax specialist with Retiring Farmers in Saskatoon.
Over a farming career that spans two, three or more decades, farmers defer income into the latter years. Inventories build up. There are significant investments in equipment and buildings that are depreciated and often livestock, he says.
“There’s a huge amount of income that’s been deferred and typically, when you sell you have to consider the income and the tax in one year.”
“But,” he continues, “there are various ways of managing that and bringing that tax bill down. It’s not to say you can in all cases eliminate taxation, but you can certainly significantly minimize it in this situation.”
An individual who owns farm property (land or buildings), an interest in a family farm partnership or shares in a family farm corporation may be able to claim a $1 million lifetime capital gains exemption (LCGE) when the farm property is sold. The actual capital gains deduction is 50 percent of the capital gains exemption.
Qualified farm property of an individual, (that is, farm property that qualifies for the LCGE) includes property owned by the individual, his/her spouse or common-law partner. It can also include an interest in a family farm partnership of the individual, his/her spouse or common-law partner.
Qualified farm property is real or immovable property, such as land or buildings, that was used to carry on a farming business in Canada by the individual, a spouse or common-law partner, parent or child of that individual, a family farm corporation where any of the persons referred to above owns shares in the corporation, or an interest in a family farm partnership of an individual referred to in any of the above.
Livestock or grain inventory is not qualified farm property and can’t be rolled over to heirs like land or a building can, says Tofin.
“You can’t get it to the next generation without paying tax on it.”
Say, for example, that a farmer has $100,000 worth of cattle that he/she wants to give to the children as a gift. The farmer will still have to include that $100,000 in his or her income and pay tax on it.
“So, create a partnership,” he says.
If a partnership is created between parents, that property can be rolled over and there are procedures that can be followed to avoid tax on that $100,000. Then the parents’ interest in that partnership can go to the farming child as a qualified farm property. You are rolling over the partnership interest that includes the value of the inventory.
“You can’t pass the cattle directly to the farming child but you could form a partnership and transfer them to the farming child. The partnership holds the inventory.”
Incorporating the farm could bring the tax rate down from 48 percent to 12 percent, says Tofin. “A farmer may incorporate for no other reason than to liquidate the farm.”
This strategy is likely the largest tax saving opportunity available to farmers that is most often overlooked.
Using the previous example of a herd of cows, the cattle could be rolled into a farm corporation well ahead of retirement. The land would be kept separate and rented to the farm corporation.
At retirement the farmer, if he/she continues to personally own the land, could sell the cattle now in the corporation. The income from the sale of the cattle would be taxed at a much lower rate than if the farmer had continued to hold them in a sole proprietorship or partnership.
Creating a holding company could be another strategy to ease the tax pain. As the name implies, a holding company exists to hold funds apart from the operating corporation.
Monies can be transferred from the farm corporation on a tax-free basis. A holding corporation can pay dividends and wages. It can make loans to its shareholders. Making non-farming children shareholders of a holding company will allow them to receive dividends.
At the same time, transferring funds to a holding company can reduce passive assets in the farm corporation, which must keep cash holdings at less than 10 percent of the value of the assets, to ensure capital gains exemptions and rollover provisions can still be used.
A tax-free savings account can be started with as little as $100 at any financial institution. Funds can be withdrawn at any time and unlike RRSPs there is no requirement to collapse your TFSA at a set age. Contributions are not tax deductible but funds withdrawn are tax-free, even upon the death of the account holder.
Note though, as of Jan. 1, 2016, the annual TFSA contribution limit decreased from $10,000 to $5,500.
“People, ideally, should start planning their exit from farming a minimum of two to five years ahead of time,” says Tofin.
“You must engage someone experienced in both of these areas — tax laws and agriculture. This is essential.
“What I would do is ask the adviser, financial adviser, lawyer or accountant … ‘how much of your workday is spent on farming issues, not preparing tax returns and financial statements, but on this specific area of farm retirement?’ ”