Many farmers hold the mineral and resource rights to the land they own.
As a result, they may be able to lease the rights to develop these minerals and earn an income off of those rights.
What many farmers don’t realize is that not all payments received on these leases or the implications of holding these rights on death are treated the same for tax purposes. As a result, there could be additional opportunities to defer the tax associated with that income.
There are two ways income can be treated for tax purposes when dealing with revenues received from surface leases or other resource rights.
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The annual lease or rental payments for the resource rights are treated as regular income and taxed the same as income from operations.
Income that is earned in a corporation will be taxed at a higher corporate rate, unless considered incidental to the farm’s main source of revenue.
Payments for damages (assuming they’re not crop damages), land im-provements, right of way and access are treated as capital payments.
Only half of the income from these payments is taxable, unlike regular lease or rental payments. In addition, an individual who owns the land could use the capital gains deduction to help offset the tax on these payments.
Knowing what the amounts are for and how they should be treated can significantly change the way the payments from mineral and resource rights are taxed.
Individuals who own mineral rights directly and plan to pass them to the next generation on death may be surprised to learn that the mineral right value is fully taxable on death and isn’t treated as a capital gain, which is only half taxable.
Let’s look at the following example:
John Smith dies while owning mineral rights and transfers the rights to his daughter in his will.
The value of the rights are determined to be three times their average annual income of $20,000 for a total value of $60,000.
Therefore, on John’s final tax return, he would pay tax of $24,000 related to these rights, assuming the top tax rate of 40 percent.
Transferring mineral rights into a corporation and reporting the revenues from them in the corporation can alleviate some of this burden.
Let’s update our example:
John Smith transfers his mineral rights into a corporation and leaves the shares of the corporation to his daughter when he dies. Assuming the rights are still valued at $60,000 and there are no other assets or liabilities in the corporation, John would pay tax of $12,000 in his final tax return, which is half of the amount in the previous example.
Individuals who are eligible for Old Age Security benefits and do not receive the full benefit because their income levels are too high can have the income from their mineral rights taxed in the corporation rather than personally by transferring the mineral rights into a corporation.
This will reduce taxable income personally as well as increase OAS benefits.
Effective dividend planning can reduce the taxes paid on resource and mineral income in a farm company. This could result in a significant tax deferral, considering that the top personal tax rates for some western provinces can be more than 46 percent.
As always, every situation is different, so talk to an adviser to determine what options should be considered when dealing with mineral rights.
