Tree Farmer’s Crop Will Take Decades to Mature. However, Tax Planning is Still Key.
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. Often providing the background financial plans and theoretical analysis for Andrew’s Farm Financial Planner column.
For the last farm financial planner article read: Farm Financial Planner: Keeping The Farm
David, a name we’re giving to a tree farmer in eastern Ontario, is 83. His wife passed away some years back. He converted a 47-acre former hay and horse farm to trees. Now there are 25,000 trees growing, a crop that he is unlikely to see mature.
The trees are varied, including black walnuts and butternuts. Each take 15 years to produce a salable crop and 60 or more years for salable timber. David’s issues at hand include the deductibility of losses for his long-term investment and, most importantly, the problem of continuity of the enterprise after he is gone.
In one sense, he can afford to wait. David’s current income is $79,280 per year or $6,600 per month. This includes his late wife’s pension survivor benefit, armed forces benefit, CPP, OAS, and RRIF income. In addition, this includes adjusting for a small OAS clawback. This is a significant surplus to his spending of $4,500 per month which includes generous gifts of $1,300 per month. His problem is both one of profitability – lacking at present – and, of course, mortality.
David has two sons that live far away and have their own financial concerns. He fears that capital gains taxes on his farm may diminish the estate he may pass to his children or charity.
Farm Financial Planner asked Don and Erik to work with David. The immediate problem is whether the farm will qualify for the $1,000,000 farmland capital gains exemption.
There are few crops that take longer to grow than trees. But David can afford to be patient. David’s net worth is $1.1 million composed of $700,000 real assets (half farm, half house) and $413,000 in financial assets. This works out to about two-thirds real assets and one-third financial assets. Based on this allocation, his farm is very similar to other farmers. With the main difference being most farmers have crops maturing in year(s) rather than decades.
In David’s case, any gain in personally-owned farmland will be offset by the $1 million Personally Owned Farm Land Capital Gains tax exemption. As well as his allowable exemption of one acre and the primary residence – a value of $350,000(apx.). This means that David will see $1,350,000 of capital gains exempt from federal income tax.
David’s children are not planning to become tree farmers. However, their potential role in the transfer of ownership has to be considered. A farming parent, can transfer land to the next generation at any price between book value and today’s market value. The best practice is to use up all the eligible tax credits and tax exemptions available. With the goal to raise the book value to the current market value before transferring title to the next generation.
David can transfer the land at a value of $700,000. He would then take off the $350,000 value of the house and one acre. Leaving a total of $425,000. This would leave him with a capital gain of $275,000. The exemption would offset the gain and leave zero federal tax payable.
There may be some tax consequences concerning OAS clawback. This starts at $75,910 and takes 15% of each dollar of income over that amount until about $123,000 when all OAS is recaptured. On this basis, for the year that the capital gain is reported the entire $7,290 of OAS would be lost. As well, there may be some Ontario provincial income tax and the federal Alternative Minimum Tax. The AMT is recoverable as a credit for future tax years.
Note that there is an exception to the OAS clawback ceiling. For more information on that here is a great article written by one of our colleagues Aaron Hector: OAS Clawback Secrets for the High-Net-Worth.
Farm Land Capital Gains Credit Qualification
There is the matter of qualification for the credit. The farmland must be a working farm. David has a certificate attesting to the farm being a federally and provincially certified “Managed Forest”. This is enough proof that it is a working farm. The CRA likes to see attempts to make the farm profitable. The CRA may investigate to ensure that the farm will become profitable if there are 7 years of continuous losses. David should have no problems proving future profitability.
Should CRA determine that the farm is a hobby, then it will not allow the deduction of expenses. Furthermore, past returns may be reviewed and more tax may be charged. CRA requires that the “farmer” make most of their income from the defined farming operation.
A few things that are necessary or helpful to prove it isn’t a hobby:
- The farmer must file a profit and loss statement with the annual tax return
- The farmer must have receipts to back up claims and other indications of running a real business
- David should have separate banking accounts for the farm
- Having a farm business plan which indicates the profitability of the trees life cycle – nuts, fruit, lumber, and scraps and cuttings
There are also some twists to observe in transferring land and tress to children. The kids can get the farm at book value because it is certified as a “Managed Forest”. For instance, this can be backed by the evidence of running the farm as a business (annual profit and loss statements filed).
The selection of transfer price depends on whether you select the lowest transfer value (BV) or a higher value. Consequently, a lower value gives the children more space to generate capital gains. Moreover, a higher value is more likely to use up your various exemptions. The lowest value is likely to be the municipal assessment value of $193,000.
Late in life, David’s issues evolve into estate management concerns. His main problem becomes the transition of a very long-term asset to children while ensuring good care for the tress. The view is long term. For the most part, trees take care of themselves. This is a huge benefit for David, as most farmers are burdened with high maintenance crops. In this case, the return on invested capital depends on the price and value of trees decades from now.
Given the farm’s annual deficit of $25,200, it would be possible to explore the idea of joint ownership. We could recommend, a neighbor, who might look after the trees if David is no longer able. Any future profits will be split accordingly with David’s heirs. Alternatively, David could set up a corporation that would employ someone to do the necessary work for pay. As an additional benefit, this would increase the odds of the CRA accepting the farm as a business.
Of course, David should run this plan by his legal counsel. If, on advice, it seems that CRA may take a negative view of the farm as a business. David could consider donating the land and trees to a suitable charity. The selected charity should have proper documentation, and a CRA registration. In addition, they should have a reasonable plan and method for providing continuing care of the trees. The chosen charity’s views should align with David’s environmental concerns.
Gifts of ecologically sensitive land, to the federal, provincial or municipal governments or approved registered charities can be made at the property’s fair market value for the purpose of the credit. But with no capital gain recognized as a tax liability.
David is in a position to make wise use of this rather unusual agricultural property. Both for his own finances, for the benefit of the land and the country.
If you are a farmer or business owner and are looking to start your succession plan contact us! The best time to start planning is now!
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