Tapping capital gains deductions associated with the selling of qualified farm property might be an appealing way for farmers to reduce their tax bills on such sales. But the calculations surrounding these deductions are so complicated and detailed that you might get a lot less than you bargained for including reduced benefit from your $800,000 enhanced capital gains exemption (CGE), says Grant Diamond, senior tax consultant with FBC, a tax advisory service with over 60 years of service to the farm community.
At the heart of the problem is something called Cumulative Net Investment Losses (CNILs). These little and sometimes not so little items work to drive your capital gains exemptions down. CNILs are largely forgotten until it is time to file a CGE claim.
Something as simple as continually claiming interest expense as a deduction on investment income gets cumulatively subtracted from your CGE claim. Allowable Business Investment Losses (ABILs) also grind down the CGE claimed in past years. Part of the problem is that interest and carrying charges are deductible for income tax purposes but such deductions become a problem when calculating capital gains exemptions.
Since 1988 net investment losses have been calculated on a cumulative basis. If the aggregate of investment expenses is greater than the aggregate of investment income then a loss occurs. But what if the cumulative total of some of those expenses must now be absorbed when claiming a capital gains deduction on the sale of qualified farm property? Then, your CGE takes a hit.
Some of those investment expenses include deductions for the cumulative total of interest and carrying charges on property that yields interest, rent or other property income and losses either from the property itself or leasing of property owned by you or by a partnership in which you are involved.
You do have some options you can use to minimize the impact from Cumulative Net Investment Losses.
As a shareholder you might charge interest on shareholder loans to corporations as a means of offsetting investment losses. You can also reduce your CNIL exposure if, as a shareholder-manager, you take your income in dividends instead of salary. Deferring interest payments to the following year will have a similar effect.
You have another option if you’re a sole proprietor or active member in a partnership. If you finance your investments by taking distributions from the partnership and then replace the distribution with borrowed money, the interest on the loan is not considered part of the CNIL.
Did we say all of this is complicated? Your ability to maximize your lifetime exemption is limited by something else called the cumulative gains limit. This is a measure of the taxable portion of your net economic gain since 1985 that is eligible for exemption but only after deducting prior gains claimed for exemption and the application of CNIL rules from 1988 onwards.
Before selling the property in question we strongly suggest you seek advice from a tax professional on how CNIL will affect your capital gains deduction.
Grant Diamond is a tax specialist with FBC, a firm dedicated to providing farmers and small business owners with expert tax services and advice for over 60 years. FBC has branches in BC, AB, SK, MB, ON and NS to serve its 50,000 Members. FBC also provides financial & estate planning. To learn more about FBC, visit www.fbc.ca. If you have any questions regarding this article, email fbc @ fbc.ca or call toll-free 1-800-265-1002.
Accurate as of April 08, 2015