Recently Widowed Linda Wants to Keep the Farm Together With a Viable Tax Plan
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.
In this installment of Farm Financial Planner we look at a recently widowed women named Linda (75). Linda lives in North-Central Manitoba on the family farm. The farm consists of 880 acres that is rented out for $1,500 per month for grain and pasture. Linda has two sons, both in their 40’s, who work off the farm. Even if her sons wanted to work on the farm, there isn’t enough land for a sustainable operation, so succession is not an issue.
There are two main problems that Linda is facing. First, Linda needs to ensure that the farm is financially viable for as long as she wants to live on it. Second, she needs to prepare for a tax friendly approach to sell/transfer the land. Furthermore, Linda needs sufficient income to ensure that a long life won’t leave her in poverty.
For now, Linda’s wishes are as follows: keep the farm and live on the yard site; keep the farm in the family; and, prepare to transfer ownership to her children while protecting it from liability or loss. She wants to live independently on the farm, but she cannot farm it actively.
Taxes and Land Values
The first issue is to deal with is taxes on the estate. Linda and her late husband can offset any gains in the value of their personally owned farmland via the $1 million Personally Owned Farmland Capital Gains Tax Exemption. Each partner is eligible for the exemption plus one acre of land around the farm house.
Linda can transfer the land to her sons at any value between the book value and today’s market value. The best course is to use all the tax credits and tax exemptions available. Doing this will raise the book value prior to transfer.
There are three values to be observed:
- Book value of the farm land, purchased in 1972, is $5,000. This land now has a large capital gain. Establishing that gain is an accounting question.
- Estimated current market value of the farmland: $900,000.
- Current market value of the house and one acre: $100,000.
It is important to select the right value for income tax payable when preparing the final return for Linda’s late husband. Linda can reduce the capital gain to $895,000. This is done by subtracting the $100,000 (house value) and $5,000 (Book value of farm land), from the $1,000,000 transfer price. By using the $1 million Capital Gains Exemption there will be zero federal tax payable.
Although no federal capital gains tax is due, there will be two other federal taxes to pay. First, the OAS claw-back which starts at $77,580. If the tax preparers for Linda’s late husband were to claim the entire gain on his return, he would lose his OAS for that year. However, this is better than the alternative. If Linda and her husband split the gain and each declare the tax on their respective returns, then both would lose OAS for that year.
The Second tax to pay is the tax due for the Alternative Minimum Tax (AMT). This will cause Linda’s late husband’s estate to have to pay tax due without the federal credits. The AMT would raise tax for estate. However, it would not produce a useful carry-forward for her husband to use in subsequent tax years. Obviously, there would be no future tax years for him.
There is more to do to protect the farm for future transfers. The title of the farm needs to be re-registered. Linda should work with her lawyer to establish a life interest in the farm and her home.
Doing this will allow her the right to occupy the property along with the requirement to receive the net income from the farm. Linda will continue to claim farm income on her personal income tax return.
The life interest is not a deemed disposition, so no capital gains need to be declared or income tax paid. That’s why it is useful for Linda to use her late husbands $1 million farm tax credit.
This life interest terminates on Linda’s death and her children would then automatically inherit the farm. The land is valued and transferred at that time, with Linda’s farmland capital gains tax exemption used and all taxes paid.
Linda’s financial future going forward is broken down as follows:
- Old Age Security, currently $607 per month,
- Canada Pension Plan an estimated $483 per month,
- Registered Retirement Income Fund withdrawal of $567 per month,
- Farmland rental income of $1,500 per month.
Her total income ends up being roughly $3,157. She would have income tax payable of $430, leaving net after tax income of $2,737 per month.
Linda’s expenses for living on the farm are speculative, totaling roughly $2000:
- Food: $500
- Car Operation: $200
- Utilities: $300
- Medical and Dental Insurance: $200
- Phone: $75
- Entertainment: $400
- Gifts: $175
- Church and Charity: $150
These expenses leave her about $737 at the end of every month. That’s a total annual surplus of $8,844.
The estate settlement process will result in a contribution to Linda’s RRSP, pushing it from its current value, $116,000, to $120,000. Her TFSA with a value of $7,000 last year, will get a contribution of $8,650. That, including the farm and financial assets will be about $1,155,650. Linda has no debt, so her net worth including a two percent adjustment for inflation and some tax due will be $1,105,000.
Linda is in good health and her life expectancy is at least another decade. Her financial problem, to keep as much of the farm as possible, is clearly settled. She will have sufficient cash and surplus income for any additional purchases she needs.
Inflation will be a problem. Her OAS and CPP income will be indexed and will be only 40 percent of her total income. Her RRIF will pay an increasing fraction of its capital. However, with the underlying investments in only interest-bearing instruments, the balance would be exhausted by age 90.
It would be prudent to speak with a financial advisor to diversify her portfolio into assets which can pace inflation and remove the certainty that the good fortune of a long life will not turn into a tragedy.
If you believe that your situation is similar or would like to partner with a trusted farm financial advisor, reach out to us. We would love to partner with you to ensure that the legacy you leave will benefit generations to come.
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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