Keeping a farm onside of the Qualified Farm Property rules and intergenerational transfer rules can be like chasing a puck on slippery ice. However, with some planning, farmers can play within the rules and be able to optimize the use of the lifetime capital gains exemption during ownership transfer.
The Canadian agriculture industry is in a state of transition with over 60% of farmers being 55 years of age or older, according to the 2021 Census of Agriculture1. Many farmers are facing big decisions about the future of their retirement, their farms, and their farming operations. But unfortunately, only 13% of farmers have written succession plans in place.
Failing to plan for the future could result in missed opportunities to benefit from farm specific tax exemptions and deferrals, and potentially leaving the family scrambling and quarreling in the event of a death.
Lifetime Capital Gains Exemption (LCGE)
The Lifetime Capital Gains Exemption (LCGE) is currently $1 million on dispositions of farm properties; the first $1M of capital gain (increase in the value of the property since it was purchased) on the sale of a qualified farm property can be tax-free. More on the qualifications below.
In general, the LCGE on a qualified farm property can be claimed by an individual for property owned by that individual, their spouse or common-law partner, or a family farm partnership. The property can be land, buildings, shares of a family farming corporation, an interest in a family farming partnership, or other property such as milk or poultry quota. It also must have been used in a farming business in Canada.
For the 24 months prior to disposition, the property must have been owned by an individual, their spouse, child, parent, or family farm partnership. Depending on the year the property was purchased, the conditions are as follows:
Purchases before June 18, 1987
The property must have been used principally (more than 50%) in a farming business by a qualifying person in the year it was sold. Alternatively, in at least five years while the property was owned by one of the qualifying persons, the property was used more than 50% in a farming business by one of those qualifying persons. If you’ve often rented out the property, it might be offside.
Purchases after June 17, 1987
It may be more complicated to qualify. In at least any two years while the property was owned by qualifying parties, the qualifying party’s gross revenue from farming needs to exceed income from all other sources and the property was used more than 50% in a farming business in which one of the qualifying parties was involved on a regular and continuous basis. The property can also qualify if during any previous 2-year period the property was used by a corporation or partnership that meets the definition in the qualified farm property rules, and an individual noted in the definition is actively engaged on a regular and continuous basis in the farming business.
- If the property was purchased before June 18, 1987, but you filed form T664, Election to Report a Capital Gain on Property Owned at the End of February 22, 1994
In this case, you have been deemed to have disposed of the property, which means you’d be subject to the tests for properties purchased after June 17, 1987. Additionally, the amount of the LGCE available to you would be reduced by this amount.
Please note that active farming does not include standard sharecropping agreements according to the Canada Revenue Agency.
Rules for a family farm corporation or a family farm partnership are quite similar. To qualify, in any continuous 24 months prior to disposition, at least 50% of the fair market value (FMV) of their assets must be attributable to property that was used principally (at least half of the time it has been owned) in an active farming business by qualifying individuals, a partnership, or corporation. In addition, one or more qualifying individuals must be actively engaged in that farming operation on a regular and continuous basis.
As well, at least 90% of the FMV of the assets owned at the time of sale or transfer must be attributable to a property that was used principally (at least 50% of the time) in an active farming business by qualifying individuals, a partnership, or a corporation. The “principally” test refers to the use of property over the entire period of ownership, so the property need not be used in farming at the time of sale or transfer.
Other specific requirements need to be met for a partnership or corporation to be defined as a family farm corporation or a family farm partnership. Indirect ownership can also qualify. For example, if a corporation’s sole asset is a receivable from a family farm corporation or shares of a family farm corporation, then it will typically be considered a family farm corporation as well.
For purposes of the QFP rules, a child can include a grandchild or great-grandchild, whereas a parent can mean a grandparent or great-grandparent.
A break in ownership outside of direct descendants (i.e. parent, grandparent, or great-grandparent) may also mean a cut-off in the eligibility of land for LCGE. For example, if the land is transferred from one brother to another, and then to the child of the first brother, the land would not qualify if the child did not farm it, even though their parent did.
Given the increase in farmland values, the $1M LCGE, although very significant, may often not be enough if the property is owned by just one person to fully protect against the capital gains that would be taxable. Planning can be implemented to optimize the use of the available capital gains exemptions of other qualifying individuals, such as spouses and children.
If you wish to transition your farm to the next generation rather than sell it to a third party, here are a few things to consider:
1. Transfer to a child
Transferring equity to a child (if they want to keep the business going) can be as simple as a gift at cost without significant income tax considerations. The increase in value, and its resulting tax impact, will transfer to the child. This could be done multiple times—generation after generation—if there is always an eligible farming heir in the family.
However, this does not allow for the use of the LCGE to offset the excess of capital gains over the LCGE amount for each heir.
Instead of transferring farm property at cost, you may want to sell land to a child for an amount between cost and FMV. For instance, a farmer may have their full LCGE available of $1M and have their land with a value of $1.6M and a cost of $100,000. You could sell the land to the child at $1.1M under the rules, and the entire $1M gain would be covered by the LCGE. The other $500K of capital gain is deferred to be taxed in the child’s hands when they sell the property. This can be done while alive, or if transferred in the will, by making an election in the farmer’s terminal return.
If the transfer is made while the farmer is alive, the impact that a capital gain will have on some other factors such as Old Age Security (OAS) income claw-back, and Alternative Minimum Tax (AMT) need to be considered. Some income-tested benefits will be affected, like the federal age tax credit, the HST credit, provincial credits for rent or property tax paid, and provincial drug coverage deductibles. These amounts can be significant and using one’s LCGE can be a tough decision to make.
Some farmers may not want any cash from their child when the property is transferred but do want to use their LCGE to increase the adjusted cost base (ACB) of the property. In this case, any taxes or extra costs will need to be paid and should be taken into consideration when structuring the farm transfer. As well, the parents should not forgive any unpaid amounts at any point prior to their death to avoid a cost base erosion through the debt forgiveness rules. This forgiveness of debt should only be done through the terms of the parent’s will.
2. Selling to a child
Until recently, if a farmer wished to sell the shares of their farm corporation to a corporation owned by their child, they would not be able to claim the LCGE and they would be subject to tax at dividend rates as opposed to capital gains rates. This was because the LCGE could not be used on sales to a non-arm’s length corporate purchaser. To access the LCGE, the farmer would need to sell the shares directly to the child or, if the sale was to a corporation, it would need to be owned by an arm’s length party.
On June 29, 2021, Private Member Bill C-208 received Royal Assent. This bill provides tax relief to families who wish to transfer shares of a family farm corporation to a corporation owned by their children, or where family farm corporations with siblings as shareholders wished to split up the corporation, by making two primary changes to the Income Tax Act:
- A change to Section 84.1 to allow the sale to non-arm’s length corporate purchasers of shares to result in a capital gain and the ability to use the capital gains exemption to reduce the income tax. This requires the purchaser corporation to be controlled by one or more children or grandchildren aged 18 or older, and the purchaser corporation must hold the shares for at least 60 months. There are a number of other requirements.
- An amendment to Section 55 to allow for certain reorganizations between family members. Prior to this amendment siblings were not considered related for the purpose of splitting up a family farm corporation between its shareholders, resulting in the need for a complicated and costly process. This relief deems siblings to be related for the purposes of these rules and enables them to use a much simpler process to split up a family farm corporation between sibling shareholders
More details of Bill C-208 can be found in our thought-leadership article.
The corporation needs to meet all the criteria listed above to be considered a qualified farm property for the purpose of using the LCGE.
Currently, the Department of Finance intends to add some legislative amendments to ensure these changes are used for genuine intergenerational transfers, and not for artificial tax planning purposes. These amendments could be issued at any time.
Transition planning and transactions are loaded with many factors to consider, including other forms of taxation such as land transfer taxes and sales tax (where applicable), or cross-border issues if farmers are engaged in sales outside the country. This information is simply an introduction to these topics. If you have any questions or need specific information regarding your own situation, please reach out to your local BDO office.
Any references made here are related to the Income Tax Act (“ITA”) unless specifically stated otherwise. Many references in the ITA refer to “farming and fishing”, however, this article addresses these issues as they relate to farming.
To learn more, read our Tax Bulletin: Tax Planning for Canadian Farmers
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