A Manitoba Couple Generates More Income and Pays Less Tax
How the couple secured retirement and transferred their remaining land to their son.
Harry, 80, and Mary, 76 had a mixed grain and beef cattle farm in Central Manitoba for four decades. They sold the home quarter to their youngest son, taking back a long-term mortgage with favorable terms. They kept 320 acres, which they have rented out to a neighbour.
Their plan was to pay modest amounts of income tax each year rather than trying to postpone the most tax possible until death when all deferred proceeds outside of Tax-Free Savings Accounts would be vulnerable to tax. The rate would be 50% or more if one adds in deferred income.
Tax Management Opportunities
Fortunately, there are many tax management opportunities. Gains in the value of personally owned farmland are offset by the Personally Owned Farmland Capital Gain Exemption. POFCGE has a $1-million limit per owner. It also includes an exemption of the couple’s primary residence and one acre. That adds up to a $2.3 Million offsetting credit on federal income tax due. Some Manitoba tax will be payable, however.
Harry and Mary can transfer their land, equipment, and inventory to their son at any price between book value and today’s market value. The couple already used some of their tax credits on other transactions. They have $763,090 of remaining farmland capital gains credit for each partner.
Allowing for the farm’s market value, estimated at $1.1 million, and deducting a farmland tax credit of $1,023,200, no federal income tax would be payable. However, Harry and Mary would each have a clawback of Old Age Security. The clawback would be roughly $7,400 per person at the time of calculation. They would also have to pay $10,000 each of Manitoba income tax.
There would also be Alternative Minimum Tax to pay. Each would have to pay $7,400 for a total of $14,800. In addition, there would be $20,000 Manitoba provincial income tax, which adds up to $34, 800. That becomes a credit toward future taxes over the next seven years but not in the year of death for which a final return is filed. The total tax bill for the sale of farmland would be $34,800.
Harry and Mary already receive income from their Registered Retirement Income Funds. The first $2,000 for each person gets an offsetting tax credit. Harry and Mary each have available TFSA room. Harry has $43,500 he can use and Mary has $17,500 she can use.
Excess Income for Other Uses
The couple has foreseeable income from their farmland until they sell it. Assuming a return net of inflation of 2.5%, $1.1 million, would have an annual annuitized income of $69,396 before tax for two decades to Harry’s age 100. With annual expenses of $36,000, they would have an annual excess of $27,400. This money could be used for travel, new vehicles or whatever else their hearts desire.
Until there is a disposition following death of the first partner, the retained 320 acres will continue to generate income and wealth. At death, the surviving spouse will get double income less most of one Canada Benefit Payment and the opportunity to split income.
For 2020, assuming assets of $1,793,000, and growth of 2.5% per year, in 10 years it will grow to $2,283,000. They can make their cash flow more dependable by adjusting their current operation. They could move from their present, mostly grain operation to diversified crops and beef cows. So, if grain prices drop, the cost of feeding their herd would decline. Furthermore, their potential future profit when the herd is sold would rise.
The same technique applies to financial assets. The couple can move away from a single crop and small portfolio risk through diversification. Historically, asset classes whether financial or agricultural do not move in perfect union. That variance is the key to asset protection through diversification. It works with formal well-known asset classes and even with unusual assets such as antiques. However, security depends on fluid markets. Real estate, for example, is visible, trades are known in land titles offices, and there is nothing odd or ephemeral about farmland or city lots.
With an excess cash flow of $27,400 per year, the couple could set aside $20,000 for investment in financial or other non-agricultural assets. They can no longer make use of Registered Retirement Savings Plans. RRSPs have to be converted to payout Registered Retirement Income Funds by age 71. However, they can fill their TFSAs each year and then build up the taxable accounts.
Well-Managed Tax Exposure
Since the second world war, stocks and bonds have had an average rate of return of 7% and 2% respectively. Assuming a 60/40 portfolio, we can average this out at 5%. We then take off our estimated 2.5% inflation for our return net of inflation. If Harry and Mary add $20,000 a year to their financial assets and obtain a net 2.5%, in 10 years they would have saved an additional $229,670. Those funds could pay for various pleasures. Perhaps travel, or gifts to the favored good causes, or transfers to family members after-tax advice.
It’s clear that a modest financial base can produce substantial returns late in life. That is as long as tax exposure is well managed and there is the view of transferring assets to the next generation.
There will, however, be bumps along the way. The death of the first partner will deprive the survivor of most of one Canada Pensions Plan benefit. As well as part or all of Old Age Security depending on amounts of income and the clawback. Lastly, the ability to split income will be lost.
The survivor may want to move to town for companionship or to hire others for caregiving. It is too late in life for the purchase of insurance for care or critical illness. Thus, building up financial resources is feasible, inexpensive, and wise.
This couple is on the way to a secure full retirement and transfer of the remaining land to the son. This plan is a sketch of how to do it and an estimate of the benefits to be had if Harry and Mary incorporate suggestions into their planning.
Check out Farm Financial Planner #15
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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