In central Manitoba, a couple we’ll call Herb, 54, and Martha, 52, have farmed for 25 years. The farm is in a partnership with Herb’s brother, who we’ll call Larry. Each brother has an interest in the partnership through his own holding company.
The main operating entity is the partnership that does the actual farming of grains and oilseeds. It owns the farm machinery, a herd of 200 cattle and 1,440 acres of farm land. The herd uses marginal land for pasture and hay. The brothers personally own another 480 acres each in their personal names. The partnership also rents another 1,600 acres.
The farm partnership has been profitable. It produces net partnership income of $150,000 to $250,000 per year. There are other investments and a revenue property which generates $8,000 a year net for the brothers. Martha has a full time off farm job which pays her $54,000 per year.
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Erik Forbes and Don Forbes of Forbes Wealth Management Ltd. in Carberry, Manitoba, worked with the couple to plan the generational transition.
The next generation wants to be involved. Herb and Martha have a son, age 27, who works on the farm and would like to have an equity interest in the entire operation. The have two daughters, ages 25 and 21, who have careers of their own and who are not interested in farming.
Herb and Martha want to retire in perhaps 11 years. They would like Larry to inherit the farm and, as well, they want to be fair to their daughters. But securing the interests of the son and the daughters will be complex.
Making the plan
The gain in the value of personally owned farm land will be offset by the $1 million Personally Owned Farm Land Capital Gains exemption for which Herb and Martha are each eligible. They can also exclude the capital gain on their primary residence with one acre. That’s another $200,000. So the first $2.2 million of capital gains on personally owned and farmed land will be tax-free, Don Forbes explains.
However, any gain in the value of the farm partnership will be taxable. Land owned by the farm partnership would also be eligible for the Qualified Farmland Capital Gain Tax Credit as personally owned land.
Farming parents can transfer land any price between book value and today’s market value. This includes any land, equipment, and inventory. The concept is to use up all tax credits and tax exemptions while not also claiming the entire value of the farm and having to pay tax on it on the date of transfer.
There are strategic choices to be made. A major consideration is which assets Larry should have. The package of assets would have a transfer price of the current book value plus the $2.2 million capital gain exemption. Any remaining taxable gain balance would be deferred to Larry through a lower conceptual “purchase price” which would be, in effect, a tax-free transfer of farming assets.
Herb and Martha can take back a zero interest promissory note on the land so that if Larry had marital difficulties or went bankrupt, the land would remain in the family. Credits or an estranged spouse could pursue Larry for the value of the assets, but he would have to pay the parents before their claims would be considered, Don Forbes suggests.
The farming corporation is more complicated. If it is a family farming corporation, so favourable farming transfer rules can be used. The alternative is to have it considered as an investment holding company. Normal business estate rules would apply to an investment holding company so that on the death of the owner, all assets are valued at current market value and appropriate taxes paid.
It would be possible to create a separate holding company to own all non-farming assets while the family farming corporation would continue to own only the farm partnership interest. Larry would be the ultimate owner of the farm partnership. For an intermediate way to provide for the daughters’ interests, Herb and Martha could buy a life insurance policy. A policy on Herb’s life for a 10-year term for $2 million death benefit would be $5,300 per year. A similar policy for Martha’s life would be $2,800 per year.
Term insurance is a good solution if it is couple with an investment plan for $40,000 to $50,000 a year. By the tenth year, the accumulated value of the investment portfolio would be sufficient to allow the term coverage to be discontinued, Erik Forbes says. There are two ways to produce retirement income from assets Herb and Martha have built.
First, use the present farming corporation as a profitable business and pay a management fee to the existing personal company. This works, but it is not the easiest path to generational transfer.
Second, have Herb take a salary of $100,000 a year and $8,000 rental income. Put $24,000 into RRSPs to reduce taxable income from the 43 per cent range to the 33 per cent range. This plan, when accumulated money is paid out on the basis of expending all capital and income would generate $4,000 per month for 25 years to Herb’s age 90, Don Forbes estimates.
Martha can use the same mechanism to generate retirement income. By adding a $44,000 bonus from the farming corporation to her $54,000 salary with $8,000 contributed to RRSPs and reduction of taxable income to the 33 per cent range, she would put $4,000 into her RRSP for 11 years and wind up with $900 per month beginning in 11 years to her age 100.
There are other ways for Herb and Martha to reduce taxes. Tax-Free Savings Accounts eliminate the problem of recurrent taxation, first on earnings and then on proceeds of savings in the form of taxable dividends, interest or profits. The maximum is now $52,000.
Eleven years from now, Herb and Martha can look forward to a six-figure retirement income and solid arrangements for transfer of their wealth to their children. Herb’s present income, which consists of $100,000 from the farming business and $8,000 in rental income, and Martha’s present income of $54,000 salary income plus $13,000 in dividends from the farming business, total $67,000, will become $87,000 salary from the farm corporation, $19,000 in dividends, $8,000 in rental income and $24,000 to RRSPs as a deduction. Herb’s final income would then be $90,000. Martha’s restructured income would be $$54,000 in off-farm job income, $40,000 in farm income and bonuses less $4,000 RRSP contributions for final income of $90,000. Total family income would be $180,000 a year after tax-advantaged contributions to RRSPs.
In retirement, each can expect the addition of Old Age Security beginning at age 65 of $6,942, earned CPP benefits of $10,560 a year for Herb and $7,800 for Martha, Registered Retirement Income Fund proceeds of $48,000 a year for Herb and $6,000 a year for Martha, and a work pension for Martha of $13,560 a year.
Total retirement income from all sources would be $279,804 for the couple. The farm interest would be transferred, Larry would have a farm business to manage, the daughters’ interests would be secured, and Herb and Martha would have a substantial income for investment, travel, or donation to good causes, Don Forbes concludes.