Farm Financial Planner: Transferring Farmland; Minimizing Taxes

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.

In Alberta, a couple we’ll call Henry, 63, and Maryann, 57, are third-generation farmers. They have 1,900 acres and a heard of 40 beef cows, far less than the 300 cows they had before the BSE crisis two decades ago. With to much land for their small herd, they rented land to neighbors and Henry went to town to do heavy machinery maintenance. It is a profitable farm, but one in decline. The issue now is the next generation. The parents want to transfer a not-very-profitable farm to adult children who want to do better.

The couple has two sons we’ll call Robert, 30, and Fred, who is 25. They have off-farm jobs but would like to farm. There are two other children who don’t want to farm.

The parents would like to retire comfortably, and allow their sons to take over the farm and be financially successful without having to take on a huge debt. Henry and Maryann consulted us for transition advice.

Our initial insticts were to be alert of any tax implications. We figured the best way was aiming to have income tax averaging 25 to 33 per cent each year. If all income is deferred until death, then the rate could be as much as 50 per cent or more if Old Age Security claw-backs tax costs are included.

The Gain in the value of the personally owned farm land will be offset by the $1 million Personally Owned Farm Land Capital Gains tax exemption. Both of the parents are eligible. On top of that there is an exemption of the primary residence farm home and one acre around it – say $200,000 in total. So the first $2.2 million of capital gains on the personally owned farm land will be exempt from federal tax.

The parents can transfer land, equipment and inventory to the next generation at any price between book value and today’s market value. The goal in choosing a cost base is to use up all eligible tax credits and tax exemptions without claiming the entire market value of the farm. If they were to claim the entire market value they would have to pay tax in the year of the transfer.

The farm has a market value of $2,880,000 and a book value of $128,000 – a capital gain of $2,752,000. The capital gains credit of $2.2 million knocks the exposure down to $552,000. There would be some Alberta tax payable, loss of two Old Age Security benefits when the gain is realized and taxed, and calculation of the Alternative Minimum Tax. The personal residence and the value of one acre continue to be free of tax on sale or transfer. That is separate from the Farmland Tax Credit calculation.

Other Issues

Henry and Maryann’s goal is a set transfer price of book value plus the capital gains exemption. Any remaining taxable gain balance would be deferred to the respective future owners through a lower notional purchase price. This amounts to a tax-free transfer of farming assets to the children.

The parents could take a zero per cent interest promissory note on the transferred land. The note should be drafted and signed while the parents are still living; it can be forgiven after the death of both parents. This protects the parents’ future income if any of the inheriting children became involved in financial difficulties; it gives the sons land title, while the parents retain control.

The restructuring of farm ownership into the hands of two of four of the couple’s children will be sustainable. However, the farm cannot support the two children’s families and Henry and Maryann. until the parents leave farm operations and retire, Robert and Fred should keep their town jobs.

The sons and the parents should formalize their arrangement with written plans, notes of amounts owing, testamentary plans drafted to include the debts, and apart from the wills, a written plan for transition from the farm run by the parents to the farm run by the sons. It may seem overdone, but documenting what is to happen will not only keep the plan in view and eliminate future misunderstandings, but will also be a base for any legal or tax issues that might arise in the future.

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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.