There comes a time when every farm will eventually need be sold. Whether the sale is made to the neighbour down the road or to the farmer’s children, planning needs to be done to ensure that the sale takes place in a tax efficient matter.
Allocation of proceeds on farm sale
Consideration on the allocation of proceeds on a farm sale is important as there are conflicting tax consequences for the buyer and seller.
Generally, the portion of the farm purchase price associated with the farm house and the half hectare of surrounding land will be exempt from tax due to the principal residence exemption. The seller would therefore want to maximize proceeds allocated to the house as much as possible in order to avoid taxable income on this portion of the sale. The buyer, on the other hand, would prefer this amount to be lower to maximize future tax free gains.
For farm equipment, buildings and production quotas, the seller will want to minimize the allocation of the price to these assets as much as possible. This is because the seller has likely claimed CCA/CEC (tax depreciation) as deductions on these assets over the years, bringing the depreciated tax cost down to a level well below cost. Any proceeds received over and above this depreciated amount right up to the original cost of the asset will be included as regular taxable income. The buyer, however, would want more value put to these assets to maximize CCA/CEC deductions against taxable income.
If the seller has any lifetime capital gains exemption on eligible farm property left to be used, they will want maximize proceeds to qualifying assets. In 2017, this exemption amounts to $1,000,000 per individual. An example of farming assets that qualify for the exemption would be land and production quotas. An example of an asset that would not qualify is inventory. The buyer will obviously prefer to allocate less value to these qualifying assets to someday use more of their own exemption.
Because of the opposing interests of the buyer and seller as noted above, it is suggested that both parties try to come to an agreement on the allocation and put it in writing in the purchase and sale agreement. This is important because the CRA could challenge the allocations if the buyer and seller report differently on each of their tax returns. If it is not possible to get an agreement in writing, some third party evidence should be obtained to support the allocation reported such as a letter of opinion from a real estate agent.
Capital gains reserve
The possibility of capital gains reserves should be considered on every farm sale. A capital gains reserve allows you to delay the inclusion of a capital gain into taxable income over a maximum of 5 years or 10 years in the case of a sale to the seller’s children.
access the capital gains reserve, the seller must take back a loan as consideration on all or part of the sale. The capital gain would then be included in income as the proceeds are received.
A reserve would be advantageous if the lifetime capital gains exemption was not sufficient to cover all of the capital gains on the farm sale. Spreading out the gain will allow more of it to be taxed at lower marginal rates and defer when the tax is payable.
Even if the capital gains exemption covers all of the gain, a reserve may still be desired to minimize the Alternative Minimum Tax which is sometimes payable even if an exemption offsets all of the regular tax on the gain.
RRSP planning is another common consideration on farm sales.
Many farmers have never made an RRSP contribution, instead preferring to reinvest as much as possible back in their businesses. As a result of these years of no RRSP contributions, these farmers have built up significant contribution limits that can be utilized to defer tax on a farm sale.
Assuming that there is adequate contribution room, the seller could make a lump-sum RRSP contribution to offset taxable income otherwise included in the year of the farm sale. The RRSP contribution could then be systematically withdrawn in a way to minimize taxes owing.
You should consult with your legal advisor to answer any questions and assist you with your farm sale transactions.