Use your capital gain exemption
Developing the right strategies and implementing the right tools can assist farm families with succession planning and farm transfers. One tool often overlooked is the capital gain exemption to help parents save taxes and gain a tax-free pension, while transferring a portion of the farm assets to their children now. Merle Good, who runs GRS Consulting from Cremona, Alta., has provided numerous seminars through the Alberta Canola, including discussions related to succession planning, tax strategies and business structures.
“At one of our regional meetings, Merle Good talked about the large number of farmers that do not use their capital gains exemption to their advantage. It is something that farmers specifically count on to preserve value in their farms and families,” says Greg Sears, Alberta Canola chair and farmer from near Sexsmith, Alta. “He talked a lot about the number of farmers going to their death without having used this exemption, and provided strategies to try and take advantage. Based on that session, my father and I visited our accountant and have developed a plan that is working well for us.”
“This is a long-term strategy that provides my parents with a much better utilization of their assets while they are still alive and saves them quite a bit of tax,”
Sears and his father have structured an agreement over 10 years, where Sears is now buying two quarters of land instead of renting, which allows his father to use his capital gain exemption and transfer that land to Sears. As well, there will be a tax savings in the six-figure range for the family. “This is a long-term strategy that provides my parents with a much better utilization of their assets while they are still alive and saves them quite a bit of tax,” explains Sears. “As a corporation, I can pay the debt down at a lower tax rate.”
A number of factors tie together to make it work, Sears says, highlighting the need for succession planning. There needs to be a discussion within the family to understand everyone’s needs and perceptions and how the plan will come together before talking to lawyers. “From a strict financial perspective, farmers spend a lot of time and energy trying to squeeze the last dime out of cost savings or the last bushel of production, but without proper tax strategies, you can throw a lot more money back to the government and out of your family by not managing that end of things properly.”
Capital gain exemption strategies
For Good, the real question to farmers is ‘Why not use your capital gain exemption while you are alive? Why wait until you’re dead?’ Many farmers are reluctant to give up control and don’t want to do anything to trigger the exemption today, but there are options that can benefit everyone. The current capital gains deduction per person in Canada is now $1,000,000.
“The reason capital gains exemption has become more of an opportunity is the current economic situation,” explains Good. “First, land has exploded in value (land in Alberta today is 30 times 1971 values). Second, personal taxes are increasing while corporate taxes are going down. And finally, living costs are increasing. With the value of land, farmers have an option to sell only one or two quarters and use up a significant portion of their capital gains exemption, while retaining ownership of the rest of their land. For a significant number of farmers, one of the options is to sell the land to yourself in the form of an operating company. This can help them retire on an approximate 14 per cent tax rate and look at a unique way to transfer land to the next generation, but still control it. You can transfer the family farm and keep your family.”
Farmers can sell three things to trigger the capital gains exemption: land, corporate shares and a partnership interest. If a land sale is made into a corporation, the farmer claims the capital gain exemption and then takes out a shareholder’s loan, which is tax-paid money. Options include taking out a portion of the money annually in the form of a salary or land rent — enough to keep in a low tax bracket at 14 or 15 per cent — then take out the rest against the shareholder’s loan. The real benefit is the corporate tax rate is currently below 14 per cent, compared to the average personal tax rate at 30 per cent. So on a two-generational farm, this strategy can, for example, take a $60,000-per-year living cost at a personal tax rate of 30 per cent and reduce that to 14 per cent tax rate, freeing up $10,000 of tax-free money to help pay for the cost of living.
Greg Sears, the Alberta Canola chair who farms at Sexsmith, has a 10-year agreement with his father to buy two quarters of land instead of rent.
”This is a long-term strategy that provides my parents with a much better utilization of their assets while they are still alive and saves them quite a bit of tax,” he says.
“This is the only industry in Canada that can do this,” Good says.
Farmers have other benefits of a shareholder loan to consider, along with creating a tax-free pension. By transferring land to the corporation, in some cases a farmer can ask to have their personal guarantee removed at the bank. With this, their personal land and assets are no longer pledged to their creditor. It also allows shareholders to purchase larger personal assets with corporate cash. More importantly, it also creates an off-farm asset for non-farm succession and estate planning. For example, it provides the opportunity to have the company take out a loan against the shareholder’s loan and give the funds to the parents. Parents can use these funds to help non-farming children purchase a house, instead of using personal high-tax cash. And it can help move excess cash and investments to purify a company.”
“Waiting to use the exemption is not the best option for many people. Consider your options and talk to your accountant to help make the best decisions for you and your family today. Why wait until you are dead?!”
This strategy can also work for smaller farms or farmers to sell land to their children and use the capital gain exemption without forming a corporation. They can sell a portion of the land to their children and claim that portion as a capital-gain exemption while still retaining ownership, and convert rental payments into tax-free income for the parents.
For off-farm children, Good has a novel idea for those who wish to own land. They could make an annual payment to their parents, just like their farming sibling, instead of putting money into a TFSA. This gives them some equity in the land they will likely inherit anyway and the parents more tax-free living money today. Their capital returns, if the parents do not have to sell their land outside of the family, for the off-farm children can usually exceed 200 to 300 per cent. This sure beats the uncertainty of the stock market! This is a different investment for the non-farming children. They develop more of an attachment to the land and, even if they are not farming, they are still eligible for the capital gain exemption when they inherit the land under the present income tax rules.
“Farmers may have good reasons to get their capital gains exemption today, either through forming a company or selling land to family directly,” Good says. “This helps convert some of the income needed for a pension or personal use on a tax-free basis, and takes steps toward a successful family farm transfer.”
The current exemption is $1,000,000 per person for qualified farm property. For land, that means the land has to have been principally in the business of farming in Canada for at least two years, where gross income from farming exceeds off-farm income. “Waiting to use the exemption is not the best option for many people. Farmers also need to consider the possibility that current exemption levels could be reduced in the future,” Good says. “Consider your options and talk to your accountant to help make the best decisions for you and your family today. Why wait until you are dead?!”