Are you considering selling your farm in the future?
If you own the majority of the farmland compared to your spouse, if you own the majority of the other family investments and if you have a much higher personal income level than your spouse, you may want to consider implementing a loan at the two percent prescribed interest rate to your spouse to help your tax situation.
Your spouse would use the loan to make investments, such as to purchase an interest in farmland from you at fair market value.
This may allow your spouse to access the $1 million lifetime capital gains exemption on the future sale of farmland (or even when it passes to the next generation). In 2019, this could result in tax savings of $237,500 to $252,000 at the top tax brackets in the prairie provinces.
Also, it may allow you to income split with your spouse. The term “income splitting” can be described as the transfer of income from a family member in a high tax bracket to a lower bracket. The individual with the lower income takes advantage of a lower tax rate, resulting in less tax as a family overall. For example, if you begin to rent the farmland out in the future, by having your spouse as an owner, they would report part of the rental income.
As you would expect, the government has limited the ways of income splitting through what are known as the attribution rules. This restricts the ability to simply gift money or land to a spouse to pay less tax.
Your spouse may purchase an interest in land from you, but must pay fair market value for attribution to not apply. You may issue a loan for the transaction.
In order to do this, your loan must meet the following strict rules:
- You must charge interest on the loan that is at least as much as the prescribed rate at the time the loan was initiated. The prescribed interest rate set by the government is currently two percent. Anything below this amount is considered a low-interest loan and attribution rules will apply.
- Interest on the loan must be paid each year by Jan. 30. If this deadline is missed, even by one day, attribution will apply to the assets acquired with the loan going forward.
There can be disadvantages to this plan. For example, if you loan your spouse funds at the prescribed rate to purchase land from you at fair market value, it will likely result in capital gains. You may be able to use your lifetime capital gains exemption against this, but do not get surprised by minimum tax.
Also, if the land decreased in value, or the return on the investment your spouse makes on assets purchased is below two percent, then the plan will not be to your advantage.
As long as you ensure the loan is implemented appropriately, income splitting using a prescribed rate loan is a useful tool in helping to reduce the amount of taxes you pay as a family. Whether looking to sell the farm soon or in the future, this is a great option to consider when planning for retirement.
Colin Miller would like to thank Riley Honess and Kim Harding for their help with this column.
Colin Miller is a chartered accountant and partner with KPMG’s tax practice in Lethbridge. Contact: firstname.lastname@example.org.