The following advice will help protect your tax savings when the time comes to sell your farm land or roll it over to the next generation.
If you are renting out your farmland, you could unexpectedly negate your ability for an intergenerational farm rollover or the $800,000 capital gains exemption or both.
In order to roll over farm property to your children on a tax-deferred basis while alive or at death, the property must have been used "principally" in the business of farming prior to the rollover.
However, Canada Revenue Agency (CRA) does not generally consider owners who rent their land on a cash or share-crop basis to be using their land in the business of farming.
CRA considers a landlord's receipt of a share of the crop to be rental income and not income from farming.
Fortunately, you have a number of ways around this, all of them related to the nature of your business arrangement.
Generally, it's best to use a custom work or joint venture agreement. As long as you maintain control over all of the key management decisions, such as which fields to plant, the crops to seed, and the times for spraying and harvesting, CRA should still consider you to be in the business of farming even if you hire someone to work the farm for a flat fee or hire a custom operator to carry out many of the farm's operations.
You would be expected to put in enough time, labour and attention to the business to contribute to the success of the business and assume any associated risks.
Joint venture arrangements, in which both parties incur expenses, participate in management decisions, and assume some of the risk, also should ensure that both parties are considered to be in the business of farming.
There also is a time and usage test that comes into play with farm rentals. Prior to 1993, land had to have been used in the business of farming immediately before the transfer to qualify for the parent-to-child rollover.
However, the rule that applies to agreements entered into since 1993 requires only that the land be used principally in a farming business at some time before the transfer - either by you, your spouse, or a child on an active, regular, and continuous basis.
In the context of such rental agreements, "principally" means more than 50% of the time.
For example, if you farmed the land for 15 years and rented it for 14 years prior to the transfer, you would meet the test. You would have farmed the land for more than half of the time.
However, if prior to the rollover you farmed the land for 10 years and rented it for 20 years to a lessee who was not your child, CRA would not consider it to have been used principally in the business of farming.
Qualified Farm Property
Another factor that will determine if the land is eligible for the capital gains exemption is whether or not the land in question meets the definition of "qualified farm property."
Real property, such as land and buildings, meets the definition only if it is used to carry on a farming business in Canada by one of the following:
- You, your spouse or common-law partner
- Your parents or children
- The beneficiary of a personal trust or the spouse or common-law partner or child of such a beneficiary
- A family-farm corporation in which any of the above persons own a share of the corporation
- A family-farm partnership where any of the above persons owns an interest in the partnership
There also are two separate tests that can determine whether your land is qualified farm property.
- The 5-year usage test
- The 2-year gross revenue test
If you meet either of these tests, you can rent your land for as long as you want and still qualify for the capital gains exemption.
If you bought or entered into an agreement to buy your property before June 18, 1987, it will be considered qualified farm property if you, your spouse, child or parent (or the other entities mentioned above) used the property principally in the business of farming in Canada either in the year you disposed of it or for at least 5 years during which it was owned by any of these individuals.
2-Year Gross Revenue Test
CRA also will consider your property to be used in a Canadian farming business if you or any of the persons mentioned above owned the property throughout at least 24 months prior to the sale.
In addition, during at least 2 years while the property was so owned, that person must have been actively engaged in farming on a regular and ongoing basis and his/her gross income from the farm business was larger than his/her income from all other sources.
One situation the Income Tax Rulings Directorate reviewed involved a woman whose father owned land that he had farmed on a full-time basis until the time he ceased farming.
When the father died, the woman's mother inherited the land and continued to rent it on a share-crop basis until she died. The daughter then inherited the land but did not farm it.
The daughter wanted to know whether it was acceptable for her father to be the person who met the gross revenue test so the land would be considered qualified farm property. This would entitle her to claim the capital gains exemption on the land's subsequent sale.
The answer was YES. The person meeting the 2-year gross-revenue test need not be the individual who owns the property and may, for instance, be the spouse, child or parent of such individual.
Therefore, for the purpose of determining if the farmland is qualified farm property in the hands of the daughter who inherited the land, her father could satisfy the 2-year gross revenue test.
Like so many tax issues relative to the business of farming, the rules governing intergenerational farm transfers, the capital gains exemption and prior use of your farm property are complex.
Make sure you consult with your tax professional to ensure your land rental agreements will not jeopardize your eligibility for a capital gains exemption or rollover of the property to your children.
If you would like a free consultation to find out how FBC can help you with your farm taxes, call 1-855-378-3628, or email today.