Farm: Capital Gain Exemption
Does Your Farm Property Qualify for the Capital Gain Exemption?
No doubt one of the biggest question farmers ask today is “can I actually sell my farm land tax-free?” If it seems too good to be true, heads up, it likely is.
There are countless rules that go along with this exemption that can lead to additional taxes payable. If the proper steps are not taken you could end up owing much more than you anticipated, even if you are eligible for the exemption. Here are just a few things to keep in mind before taking advantage of one of the biggest tax breaks offered to farmers.
Generally speaking, farmland, quota, and buildings are considered eligible for the capital gain exemption; as well as interest in a farm partnership and shares in a family farm corporation. Since only property qualifies for the exemption, farm machinery is not eligible, nor is inventory.
There are two methods to use when determining if your property is eligible for the exemption and it's based on when the property was acquired.
- For property acquired on or before June 17, 1987 the property must be used in farming by a permitted user* in the year of sale or for at least five years preceding its sale. This method is simple and straightforward and in true CRA fashion was too easy to last.
- For all property acquired after June 17, 1987 the property must be owned continuously by a permitted user for 24 months prior to the sale and in any two years of its ownership by a permitted user the user’s gross income from farming must exceed their net income from all other sources of income. This means that many hobby or part-time farmers may not qualify. This income test is dropped for partnerships and corporations if one of the partners/shareholders, which is a permitted user, were actively engaged in the farming business for at least 24 months prior to the sale. 'Actively engaged' is a term that applies to those who spend more time on the farm than any other income generating venture.
I’ve sold my farm property and am eligible for the exemption, now what?
The first step is determining how much Capital Gain Exemption (CGE) you have. As the CGE is attributed to the taxpayer and not on the land itself you can use up portions of your exemption over your lifetime and you could eventually run out before you run out of property to sell.
- As of April 21, 2015, the lifetime capital gain exemption was increased to $1 million. However, if you used part of the CGE in prior years your remaining exemption will have been reduced. Also note if you made an election in 1994 to trigger the CGE of $100,000, that was available to everyone up to that time, and crystallized the gain on your property you unfortunately surrendered $100,000 from your farm CGE and now only have $900,000 left-over. Furthermore, this triggers a new acquisition date of 1994 effectively changing the rules needed to qualify for the CGE.
The next step is determining how much of a capital gain you will be reporting on your tax return, because yes, even though the whole sale could be tax-free the gain must still be reported as income, and then a deduction is made later to remove it from taxable income. If you received the full amount of sale proceeds, (simply put) you must report the gain all in one year. If instead you will receive the money in instalments you can elect to claim a reserve and report a portion of the gain this year and report the rest in other years up to a maximum of 5 years (10 if selling to your child).
The rule is that you MUST claim the full gain by the time the 5 (or 10) years are up even if the full proceeds have not been received. What you can report must be either the percentage of the gain compared to the total proceeds received or 20% (10%) per year, whichever is higher.
“Why would I bother splitting up the gain when the full amount is not taxable?”
Even though the sale may not increase your taxable income, you may still end up having an amount owing. As mentioned, the sale is reported on your return giving you your net income and later a deduction is claimed to bring you to your taxable income. This means that all benefits that you receive that are calculated based on your net income will be affected; such as:
- Old Age Security pension (OAS)
- Employment Insurance (EI)
- Guaranteed Income Supplements (GIS)
- Canada Child Benefit (CCB) and
- Some credits
As if that wasn’t enough, the CRA also has a method of calculating tax that does not consider any of a taxpayer’s tax breaks.
This is called Alternative Minimum Tax (AMT). However, this is not a tax that only applies to sales of farm property. This calculation is done on every tax return produced. If a taxpayer has a capital gain, usually only half of it is taxable and the other half is tax-free. This calculation eliminates that. It also forgoes the CGE, among other possible tax breaks and calculates a tax payable on the lowest tax rate (15% for 2019). If this amount of taxes owing ever exceeds a taxpayer’s regular amount owing this must be used instead of the regular amount.
The only silver lining is that this 'extra' amount paid can be used against taxes owing for the next seven years but if you do not owe tax after the sale of your farm property you can consider that money gone.
With proper planning there are ways to avoid, or minimize, the amount owing on the sale of farm property. However, often these strategies take several years to put into place.
For further information on sales of qualified farm property, do not hesitate to give our Ag Team a call.
* Permitted users include:
- The selling individual
- His/her spouse
- Any of the individual’s children or grand-children
- The individual’s parents or grand-parents
- A personal trust where any of (1) to (4) are a beneficiary