A couple works out a farm transition plan for three children. The plan includes financial security for all, including a son with a disability.
A couple, Max, 86, and Lily, 81, have farmed 480 acres in western Manitoba for the last 60 years. Their eldest son, Sam, now 60, retired from a city job with a solid pension. Sam now farms with his parents. He is a registered co-owner of the home 320 acres and will automatically inherit this land when his parents pass on.
Their daughter, Nancy, 58, has already received $440,000 in cash to buy herself a new home. The parents’ concern now turns to their youngest child Bob, 46. Bob had a major accident and is now living with a disability. He lives apart from Max and Lily and his income is dependent on disability benefits.
Max and Lily are interested in how to structure a support plan for Bob. However, they are also concerned about treating their other two children fairly. The basis for a plan has to be an estate plan and use the Qualified Farmland Capital Gain Tax Credit and other tax planning routes.
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 Foundation of the Farm Plan
The foundation for a plan is the current book value of the farm plus the capital gain exemption, now worth $2.1 million for the couple. Any capital gain over this level would be deferred to the new owners through a purchase price to be determined. The exemption plus capital gains tax deferral will accomplish a tax-free transfer to the children.
The gain in the value of personally owned farmland will be offset by the $1 million Personally Owned Farmland Capital Gains Tax Exemption for each partner. In addition, the exemption of the couple’s primary residence and one acre worth an estimated $100,000. That’s the $2.1 million in exemptions.
The transfer price can be any value between book value and today’s market price. This includes not only the land but also the farm’s equipment and inventory. The concept is to use up all available tax credits and exemptions without claiming the entire market value of the farm. This avoids the obligation to pay tax on the date of transfer.
A parallel capital gains calculation will apply to the transfer of the rest of the farm.
The Details of the Farm Plan
Assuming the three-quarters of farmland has a value of $1,336,900 and a book value of $48,000, the taxable gain will be $1,288,900. There would be an offsetting capital gains tax credit of $1,228,900, assuming land value of $100 per acre.
If the transfer happens before the parents’ deaths, there would be Manitoba tax payable and a resulting clawback of OAS, now $7,384 per person per year. The Alternative Minimum Tax (AMT) would apply before death. The AMT is a carryforward credit, but it does not apply in the year of the taxpayer’s death. There would be no tax on transfer of the farm home and one acre of land. Moreover, any life insurance benefits are tax-free. Funeral expenses could be paid out of money held in Tax-Free Savings Accounts.
Financial Security for Youngest Son
Bob will need financial support after his parents die. Structuring the support is complex. There are several choices including the following:
- Under a federal Registered Disability Savings Plan (RDSP), Bob can contribute up to $1,500 annually. He would receive a matching grant from the government of $3,500. All income and any capital gains are sheltered inside the RDSP. The maximum lifetime contribution limit is $200,000 before age 59. There is a maximum lifetime grant of $70,000 by age 49. For low-income applicants, the federal government provides an additional $1,000 grant per contribution up to a $20,000 lifetime limit. The maximum carryforward for grants is $10,500.
- There are other options. Withdrawals for any reason can start at age 60 and money from the deceased parents RRIFs can be rolled into the RDSP.
- The strategy to use, therefore, is to transfer proceeds of the parents’ RRIFs within their wills. The proceeds of their RRIFs can be transferred directly to a Lifetime Benefit Trust for Bob as sole beneficiary.
- At the parents’ death, a Qualifying Trust Annuity must be purchased by the Lifetime Benefit Trust funded by the RRIF proceeds. The term of the Qualifying Trust Annuity must be a fixed term equal to 90 years minus Bob’s age.
- In Bob’s case, the trust would be funded with $300,000 to buy a 44-year fixed term Qualifying Trust Annuity. The annuity would pay about $900 per month. Income would have to be reported to the Manitoba disability support program.
- An alternative is to create a discretionary trust for Bob with a legacy of $100,000 or less. The trust, called a Henson Trust, gives the beneficiary, Bob, no right to income or other proceeds. The Henson trust leaves payments to bob in the hands of the trustees. Income paid out is counted towards the income limits.
- Max and Lily could create a family trust. It would probably be seen as Bob’s trust and thus the province would probably insist that all trust assets be drained before any provincial disability support benefits are paid to Bob. However, the family trust would be flexible, allow the family to control assets, and have the discretion to increase support to Bob. In this path, there would be a need to pay out all family trust assets while differing other benefits.
The Final Objective
The goal should be to maximize Bob’s RDSP contribution limits, set up a Henson Trust with $100,000, and make Bob the beneficiary of RRIFs for the purpose of funding a lifetime benefit trust with Bob as the sole beneficiary.
After transfers to Sam and Nancy, $800,000 of cash and other assets will be left over plus 160 acres of farmland. If divided equally between Sam and Nancy, then Bob will be disqualified from all future provincial disability programs until his legacy is used up.
If land or other assets are transferred to Sam and Nancy, the parents should take back a zero-interest promissory note payable on demand. This ensures that a martial breakdown would not allow a spouse of either child to demand a partition of marital property.
If the parents decide to liquidate the farmland, they can maximize their Tax-Free Savings Accounts. Each will have$75,500 contribution limit in 2021, plus $6,000 per year for subsequent years.
With all of these steps taken, Max and Lily can count on two Old Age Security payments of $614 per month. These payments will increase with inflation. They will also have two Canada Pension Plan benefits totaling $1,136 per month. There will also be a work pension of $700 per month, RRIF income of $2,116 total per month, land rent of $1,274 per month, and investment income of an estimated $960 per month.
That is a total income of $7,414 for the couple or $3,707 each after sharing eligible income. If taxes are $1,400 per month, the parents would have an estimated $6,014 per month to spend.
Their house would be free of debt and only property tax, utilities, upkeep of the yard and buildings to be paid. Their children would be financially secure and Bob’s interest would be looked after in financial terms for his life.
For more information on RDSPs check out What You Should Know About the RDSP
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