Capital gains exemption can be used in variety of ways

We have been receiving numerous calls from farmers asking about their lifetime capital gains exemption.

Obviously, people are worried that the government will need new tax revenue streams soon.

At a high level, we always want decisions that make business sense first. We then work in the appropriate tax planning.

If a farm has been looking at transactions that would use the lifetime capital gains exemption, you could consider accelerating the transaction timing.

The lifetime capital gains exemption for qualified farm property is $1 million. This exempts you from paying tax on $1 million of the gain on the sale of qualified farmland or shares in a qualified farm corporation (ignoring alternative minimum tax). This provides you with significant tax savings, about $240,000 (depending on your province of residence) at today’s top rates.

Qualified farm property is real or immovable property that was used in the course of carrying on a farming business in Canada.

Typically, if you are a full-time farmer, land that you use in your farming business would be considered qualified farm property.

However, these rules are complex. You should ensure you qualify before moving forward with any transactions. Depreciable property, such as irrigation equipment, tractors, combines and trucks, does not qualify.

Let’s look at an example. If you sold land for $800,000 and your original cost of that land was $200,000, you would have a capital gain of $600,000. Before the exemption, this would result in about $150,000 in tax (at the top rate).

In this situation, you would use $600,000 of your lifetime capital gains exemption to save this tax. You would then have $400,000 of your lifetime capital gains exemption to use against future sales.

One thing that catches people is paying alternative minimum tax when they thought it would be a “tax-free” sale. The government wants you to pay something in a year that your income is so high before the exemption. However, this can be viewed as a prepaid tax that can be recovered in the future with proper planning.

There are many different scenarios where the lifetime capital gains exemption can be used:

  • Selling land to a third party. If your land is in a corporation, you could consider selling the shares of the corporation to utilize the exemption.
  • Selling land to your farm corporation to extract excess funds or create a shareholder loan to draw cash tax-free in the future.
  • Selling land to your children as a part of succession planning. This allows a promissory note to be created to take tax-free payments from your children or provide protection against events such as divorce or a future sale of the land by the child. Your child then has a higher cost base on the land to lower any of their tax in the future.
  • Selling land to your spouse. This can be done through an election to use the exemption and potentially help with income splitting with your spouse taking future income from the land purchased.

It is important to consider the best ways to multiply lifetime capital gains exemptions. This includes ensuring your affairs are in order for your spouse to eventually use the entire exemption.

These can be complicated rules that cause unforeseen tax exposure. Be sure to discuss any plans to sell property with a tax and business adviser.

Colin Miller is a chartered accountant and partner with KPMG’s tax practice in Lethbridge. Contact: colinmiller@kpmg.ca. He would like to thank Riley Honess and Ashton Phillips of KPMG for their assistance with writing this article.

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