This article was originally published in Grainews. Grainews is an agricultural based publication written for farmers, and often by farmers, in a style they understand. Don and Erik work closely with author Andrew Allentuck, providing the background financial plans and theoretical analysis for Andrew’s Farm Financial Planner column.
The Farm Financial Planner column has recently come to an end in the Grainews publications. However, we have had requests to continue on with the content, so we intend to post it here regularly.
For a widow needing to raise cash, a charitable donation could hold down taxes.
A central Manitoba widow we’ll call Edna, 67, has a 320-acre farm she is no longer able to run. She thinks she can get $800,000 for the property. It’s clear of loans and any liens, so the sale should be quick and clean.
Edna needs to raise her income. At present, she has only $2,000 per month in total from Old Age Security ($590), Canada Pension Plan ($317), Registered Retirement Income Fund ($183) and farm rental cash flow ($1,000).
The land sale would raise $800,000 before taxes. With a $160,000 book value, the capital gain, $640,000, would be exposed in the normal course of things to a 50% inclusion rate. Under normal circumstance, the taxable gain, 50% or $320,000, would generate a taxable bill of $100,000 or more.
Edna came to Forbes Wealth Management for planning and guidance.
The first objective is to reduce or eliminate the capital gains tax. The land, though currently rented, is eligible for an offsetting Qualified Farmland Capital Gains Exemption, thus the taxable gain would be zero.
That tax benefit triggers the Alternative Minimum Tax (AMT), and, as a result, a $22,000 AMT is charged and has to be paid. The $22,000 is a potential credit against future federal tax payable over the following 10 years. However, Edna won’t have much tax to pay for the next decade, so the $22,000 AMT becomes an outright tax. The AMT also triggers a provincial tax of $11,000.
The income surge caused by the land sale puts Edna’s income is above the trigger for the Old Age Security recovery tax, which is $74,788 in 2017. As a result of the clawback, Edna would lose all of her OAS for the year in which she declares the capital gain. There are ways to deal with the cost, however.
In Manitoba, the first $200 of charitable donations receive a 25.8% tax credit. Any amount above that limit gets a 46.4% tax credit. A $76,000 charitable donation would eliminate all of Edna’s Alternative Minimum Tax and provincial taxes. The savings would be $32,789. Charitable donations will not affect OAS clawbacks; it will still bite. However, it is just a one-year cost.
Edna’s small Registered Retirement Income Fund will continue to pay out at a rate of $2,000 per year or $167 per month. The amount will be offset by the $2,000 pension credit so it will have no tax. In 10 years, the RRIF, which is growing at six percent per year with investments in conservative telecom and utility stocks, will be depleted.
Edna’s Tax-Free Savings Account has a zero balance. She should max it out every year as contribution space becomes available. In 10 years’ time, the account with a $57,500 limit for 2018, will gain total additional space of $55,000. If Edna invests in stocks with dividends in a range of three to six percent, with some capital growth, she can average six percent before inflation adjustments, resulting in a $175,000 balance in 10 years. That balance can pay $15,250 per year or $1,354 per month for 20 years till Edna is 97. After the charitable donations are made and the TFSA is maxed out, there will be $650,000 cash left in the account.
Edna will now have CPP of $317, OAS restored after the one-year capital gains driven clawback, of $590, RRIF income of $167 per month and investment income of $2,165 per month, total $3,239 before tax. Much of that would be a return of capital and not generate a tax liability. Moreover, Canadian-source income would benefit from preferential tax rates, courtesy of the dividend tax credit. In 10 years, the RRIF $2,000 annual income will be gone, but invest income of $2,165 per month and TFSA income of $1,354 per month, total $4,426 will be her permanent income. At 97, the TFSA income will be gone, but Edna will still have her house, and her CPP, OAS and investment income.
[Edit] Now that contribution room has increased to $6,000 per year starting in 2019, after 10 years the balance would be about $182,000
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Disclaimer: This Forbes Wealth Blog is for informational purposes only and does not constitute financial, legal, or tax advice of any kind. Please consult your legal, accounting, tax, investment, banking, and life insurance professionals to get precise advice relating to your particular situation before acting upon any strategy.