Under certain circumstances, Canada Revenue Agency (CRA) will class woodlot sales as a capital gain instead of ordinary income. This tax advantage is primarily for farmers, but you must follow strict rules to qualify.
If you sell timber from a wooded area on your property, the proceeds could be taxed as either ordinary income or as a capital gain.
With capital gains, only half of the income is taxable, so this is the preferred treatment. To determine the tax treatment, CRA considers whether farming is your chief source of income, whether you operate your woodlot as a farm, and whether the woodlot is commercial or non-commercial.
Sale of timber from your property may be classed as capital gains if you operate a non-commercial woodlot, but sales must meet all of the following conditions:
- You could not have acquired the property with the intention of selling the timber.
- Someone other than you must cut and remove the standing timber.
- Your agreement for sale of the trees must be an isolated or infrequent transaction.
- Price for the timber must be a fixed amount, as opposed to being based on board feet or cubic meter.
- Timber can be removed only over a short period of time, usually less than 6 months.
- Purchase price cannot be dependent on the use or production of the land.
In addition, if you meet the above conditions and you are in the business of farming, the capital gain on timber sales may qualify for the $750,000 capital gains exemption if the woodlot property can be considered "qualified farm property" (QFP) and otherwise meets the farm usage, ownership and profit tests under the Income Tax Act.
A September 2005 case in the Tax Court of Canada clearly illustrates the need to prove you are in the business of farming to get the capital gains deduction.
Vancouver Court Case with Unfavourable Results
The case involved the sale of timber from a rural property in Quesnel, B.C. CRA had disallowed the capital gains exemption on timber sales during the years 1998 through 2000 on the basis that the timber sold did not constitute "qualified farm property". By Income Tax Act definition, QFP includes "real property that was used ...in the course of carrying on the business of farming...."
Evidence presented in Tax Court showed that Mr. and Mrs. Omer and Dorothy Healy had acquired the B.C. property in 1974. The property included 220 acres of land, plus a house, barn, sheds and a trailer. About 12 acres had been cleared for growing hay, while another 40 acres were timbered. The rest of the land was covered with overgrown brush.
The Healys had lived in Vancouver prior to buying the property. But Mr. Healy wanted to raise his daughter on a farm because he had fond memories of his childhood spent on his grandparents' farm.
From the mid-'70s to the mid-'90s, the couple kept some livestock and grew hay on their property. The number of animals was fairly constant over that time period:
- About 6 cattle
- 1 horse
- 3 pigs
- 50 chickens
- A couple of ducks
- Afew turkeys.
The Healys butchered some cattle each year to provide meat for the family, and gave some meat as gifts and as payment to neighbors who helped harvest the hay. They sold only one head of cattle during the 20 years. The couple also butchered one pig each year for their own use. Mrs. Healy sold some eggs to neighbors, but did not track the revenue. Their hay was used to feed their animals - none was sold. The lone horse was kept for the daughter to ride.
Up until about 1995, Mrs. Healy took care of the farm animals and helped with haying and fencing because Mr. Healy was often away working as a plumber and pipe fitter. At that point, when she couldn't look after the animals anymore, they were sold or slaughtered.
A couple of years later, Mr. Healy decided to retire from his trade and spend more time farming. He arranged for logging of the 40 acres of timber to provide funds for retirement and farming. Timber sales generated about $155,500 in 1998 and $47,500 in 1999, resulting in capital gains of about $100,000 and $28,500, respectively. Mrs. Healy continued the logging after her husband's death in 1999, and realized capital gains of $50,400 and $13,200 in 1999 and 2000.
In reviewing the evidence, the judge denied the Healys' claims for capital gains deductions saying they had not carried on the business of farming in a commercial or business like way. They presented no documents or financial evidence as proof of same.
In fact, it was clear there was a considerable personal element to their "farming" activities. The property was their principal residence, and they had bought it in the first place to raise their daughter in the country. Much of the meat raised on the property was for the family's own consumption.
In addition, the judge also denied Mrs. Healy's appeal claim for a deduction of farming losses of $1,260 and $6,199.23 in 1999 and 2000 respectively. Mr. Healy had only ever claimed farming losses for 1981 and 1982 for income tax purposes.
To get the capital gains deduction for a woodlot, you have to be in the business of farming and the wood you sell has to be treated like a capital asset. You sell it once and it's gone.
Another scenario is the taxpayer who operates a woodlot as a commercial enterprise. Generally speaking, where a taxpayer operates a woodlot as a business with reasonable expectation of profit it is considered a commercial woodlot.
Sales of timber from a commercial woodlot will be taxed as business income if payments were based on the use of or production from the property. For example, a woodlot owner might give someone the ongoing right to cut and take timber from his lot over a period of time, and for that he is paid based on the volume of timber taken.
If the commercial woodlot is mainly operated as a logging business it is not considered to be a farm operation.
However, if the woodlot involves the planting, nurturing and harvesting of trees according to a forestry management agreement and considerable time is devoted to managing the growth, health, quality and composition of the trees, it generally is considered a farming business. You still have to count sales as income, not as capital gains, but you do have the tax advantages of a farm.
In the case of a commercial woodlot operated as a farm, income and expenses related to tree production such as seeding and harvesting are allowable under government risk management programs.
Income and expenses generated in the harvesting of trees for use as firewood, construction material, poles or posts, fiber, pulp and paper, or in reforestation are not allowable under these risk management programs. Income generated from such sales is excluded from production margin calculations.
CRA's Interpretation Bulletin IT-373R2 "Woodlots" deals with the tax issues for owners and operators of woodlots, including woodlots operated as farms. It also discusses the criteria used by CRA to determine capital gains versus income treatment and eligibility for the capital gains exemption.
Determining the income tax treatment of timber sales from a property can, like most tax issues, be quite complex. It's best to talk with your tax advisor in advance about the tax implications of selling timber from your property.
Court Ruling in Favour of Timber as Capital