The capital gains exemption is the single largest tax break that farmers receive, but the issue can get quite technical
Farmers, like most business owners, can take advantage of tax deductions on all sorts of expenses.
But when it comes to tax planning, few things can compete with the $1 million capital gains exemption on farm property.
“If you asked me what’s the most common tax question I get asked, it would be a no brainer — capital gains,” Erich Weber, business and finance specialist with Ontario Agriculture, wrote on the ministry’s website.
“The reason for all the interest is because the exemption is the single largest tax break that farmers get. Although good tax planning may yield even larger benefits over time, the capital gains exemption is seen as the ‘big one.’ ”
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In 2015, the federal government increased the lifetime capital gains exemption for “qualified farm properties” to $1 million. Because it is the “big one,” producers want to understand how it works before they sell the farm or transition to the next generation, Weber said.
“I think it’s one of those situations where they (farmers) are trying to figure out what to expect,” he said from his office in Guelph.
“They want to be able to go and talk to their accountant, or their lawyer, and have a rough idea of what they are saying. Let’s be honest. It can be pretty technical.”
To explain the basics, the Ontario ministry has published a Top 10 list of questions regarding the capital gains exemption on its website.
A few of the questions deal with eligibility.
For example, if a farm owner leases the land to a tenant, is the farm owner still eligible for the exemption?
The answer: it depends.
If the property was purchased on or before June 17, 1987, it must be used in farming at the time of sale or for any five years during its ownership.
If purchased after June 17, 1987, it gets more complex.
The Canada Revenue Agency says the property should be “used principally in a farming business … in which the individual, spouse, child or parent is actively engaged on a regular and continuous basis.”
The key words in that sentence are “used principally” and “actively engaged.”
Royal Bank, in a document on the capital gains exemption, says leasing the land or crop sharing don’t meet the requirement.
“These arrangements are generally considered to generate rental income, not farming income,” the bank says.
“If the farm is leased to tenants or involved in a share-cropping arrangement for a majority of the ownership period, the assets may not meet the criteria of qualified farm property.”
When it comes to “actively engaged” in the farm, the Royal Bank describes that as an individual, spouse, child or parent who is involved in the management of the farm or the day to day operation of the farm.
“That person would be expected to contribute time, labour and attention … (so) their contributions would be a factor in the successful operation of the business.”
However, if a landowner is paying for inputs and assuming the financial risks of farming, the CRA may view that situation favourably, Weber added.
“As a (land) owner, you buy the inputs and the crop will be yours … but you get your neighbour or somebody down the road to do the work for you.”
Another common question is about selling the farm to children and then the kids sell the farm, thus doubling the capital gains exemption.
Such a manoeuvre is a gray area and risky, Weber said.
“The assumption is that the sale to your child below FMV (fair market value) would use up your exemption, and then when your children sell it they would use their exemption,” Weber wrote on the ministry website.
“Tread carefully here. If you sell the assets within a three-year period or even make arrangements to do so, Canada Revenue Agency will consider this to be tax avoidance.”
Being tax law, the capital gains exemption is complicated.
Farm owners should meet with their accountant or lawyer and talk through the options, Weber said.
Before that meeting, farmers should gather information and put together a list of questions.
“The wrong time to ask questions, like everything else, is after the deal is done.”
