Tax, Transition Planning and the Modern Family

While many family-owned farms have the long-term objective of passing the operation on to the next generation, this is often a complex process which requires thoughtful, in-depth planning and communication. The aspirations of both generations needs to be addressed along with the practicality behind whether or not the operation will be capable of supporting everyone involved. And then, there’s the modern family — and all of the tax and transition nuances that come with it.

 

If you take a moment to consider your relatives, friends and colleagues, there is a strong chance you know several blended families. In fact, according to a recent Canadian census, 12.6 % of all families in the country are blended with stepfamilies representing about one in eight families with children across the country. Sound familiar? If you’re one of thousands of families in this situation, financial, transition and estate planning will likely have to take several other decisions into consideration.

 

One of the things I’ve certainly realized is dealing with family issues with our transition smart team, our older clients often have a tendency to concentrate on the tax issues. Where I see great benefit is when they address the issue of whether mom and dad have enough money for retirement, how the owner ship is going to look — do the kids have the skill sets and business knowledge to carry on the farming operation — do they have the marketing knowledge to market their farm appropriately. Once we decide all of that — based on the defined goals and objectives of the family, it’s then important to come up with the most tax efficient structure to transition the farm from one generation to the next — which is partly estate planning depending on dynamics of the family.

 

• The property must be land, depreciable property, eligible capital property, interest in a family farm partnership or shares in a family farm corporation.
• The property must transfer to a child that is resident in Canada immediately before the transfer.
• The farm property has been used principally in a farming business in which the taxpayer, taxpayer’s spouse or common-law partner, a child of the taxpayer or a parent of the taxpayer was actively engaged on a regular and continuous basis.

Lifetime Capital Gains Exemption

When an individual or family decides to sell his/her/their farm property, the capital gain exemption of up to $1,000,000 may be available. For example, if an individual owns farm land personally (meaning there is no corporate structure is in place), the capital gain exemption may still be available upon the sale of some of the farm land. If you decide to transfer your farm land over to your children or spouse, no taxes have to be paid on the capital gains until they sell the farm. Since each of your children is entitled to a $1,000,000 capital gains exemption on a qualifying farm property, they could dramatically reduce or even eliminate any of the taxes that would otherwise be payable on the sale of the farm.

In order to be eligible for the capital gains exemption, the farm must meet certain qualifications.At the time that you roll your farm over to your children or upon your death, its principle use must be the business of farming. For example, if you were to rent out your farm and take a share of the crop, it could be considered to be rental income as opposed to farm income and you could lose the capital gains exemption. Furthermore, if you are owning more income in an off-farm job than you are from your farm, it may not be eligible for capital gains exemptions.

Generally speaking, qualified farm property is property owned generally by an individual or their spouse that is the following:
(a) Real or immovable property and eligible capital property used to carry on the business of farming in Canada generally by:

i. the individual, their spouse, parent, this also includes the grandparents and great-grandparents) or child;

ii a family farm corporation whose shares are owned by an individual, their spouse, parent or child; or

iii. a family farm partnership where an interest is owned by the individual, their spouse, parent or child;

(b) Shares of a family farm corporation owned by the individual or the individual’s spouse; or

(c) An interest in a family farm partnership of the individual or the individual’s spouse.

The Blended Family Conundrum

Given the key considerations listed above and the role children can play in farm transition planning from a tax perspective, there are complexities which accompany today’s change in family dynamics where second marriages are common and we have blended families with step children. One of the things we have to consider carefully is ‘does a relationship exist from transferring qualified farm property from the parents to the children?’
An Example

Let’s say we have a husband and wife who have two children together. The husband passes away and the wife chooses to remarry a farm owner and operator. If the new husband ends up getting along with his step-children and has a significant amount of farming assets, he may ultimately want to leave his farming assets to his step-children. Provided all other farm tests are met during his lifetime, transitioning farm assets to his step-children would be fine as he is related to them and they are considered his children through the marriage. However, if his wife predeceases the farmer before that transition takes place, the step children may no longer be considered a “child” for income tax purposes and there will be no ability to transfer eligible farm assets on a tax-deferred basis to former step children. The effect then, is a taxable event when the farm assets are transferred for former step children.

Currently, the way the Income Tax Act is written, unless there was a formal adoption or can establish in fact or law that child before turning 19 was wholly dependent on the farmer for custody and control, they will likely not meet the criteria for an intergenerational rollover. The Income Tax Act’s definition of a child includes

• a person of whom the taxpayer is the legal parent;
• a child of the taxpayer’s spouse or common-law partner;
• a spouse or common-law partner of a child of the taxpayer;
• a child of the taxpayer’s child;
• a child of the taxpayer’s child’s child;
• a person who was a child of the taxpayer immediately before the death of the person’s spouse or common-law partner; and
• a person who, at any time before the person attained the age of 19 years, was wholly dependent on the taxpayer for support and of whom the taxpayer had, at that time, in law or in fact, the custody and control.

In the above scenario, a professional tax and succession team would help the family come up with a feasible solution that allowed the parents to transition out of their operation on their own terms, while securing the future of the farm and allowing for the best possible outcome for the step-children. Some viable solutions may be:

• The parents transfer farm property to children during their lifetime to ensure tax free transfer rules are met.
• Have step parents transfer remainder interest in the land to step children and retain a life interest on the land to protect the income source for parents.
• The stepparent transfers the property to the mother as a gift and they revise the mother’s will to leave the farm directly to her children.

In Conclusion

The family farm is a vital contributor to Canadian culture and the economy. Maintaining a thriving farm operation is no small task, given the level of financial commitment, opportunity and risk associated with day-to-day operations. If you dream of passing the farm down to the next generation and that generation happens to be multi-dimensional, it’s crucial to prepare a succession plan as unique and multi-faceted as your family is in order to ensure you’re not only exiting on your own terms, but laying the foundation to position your farm for prosperity and success not just for tomorrow, but well into the future.