In central Manitoba, a couple we’ll call Harry, 58, and Linda, 56, have run a 2,240-acre grain and oilseeds operation for 35 years. Their farm income has been supplemented by Linda’s consulting practice with a large company. They have two adult children in their 30s who are not likely to carry on the family farm, yet the door is not closed. They might decide to keep the farm going.
Harry and Linda have to decide whether to keep farming or to sell the farm. They asked Don Forbes and Erik Forbes of Forbes Wealth Management Ltd in Carberry, Man., for assistance in drafting a plan.
There are three ways to go, Don Forbes explains. Each is a different scenario for the children participating in the farm’s future.
Scenario 1: Keep the farm and rent out all 2,240 acres at $60 per acre net after expenses. That would generate annual gross farm income of $134,400. That’s $11,200 per month and, depending on tax rates in combination with other income, it would be sustainable for as much as 40 years, Don Forbes estimates. This ties the parents to the farm indefinitely.
Scenario 2: Rent 960 acres, sell 1,280 acres. The rent (at $60 per acre) plus the sale value of the remaining land ($1.6 million), would generate $137,600 per year, or $11,500 per month. This leaves a smaller farm for the children, but still gives them the option to farm if they wish.
Scenario 3: Sell all 2,240 acres and relocate. If the land sells for $2,000 per acre, the parents would have an annual income of $224,000 — $18,670 per month. This excludes the children from future farm operation.
Making the choice
The choice of strategy should be driven by the children’s plan to take over the farm and by tax considerations, Erik Forbes says. This leads the advisor to recommend Scenario 2.
It’s better for the couple to pay moderate income tax each year in a range of 26 to 35 per cent, rather than attempting to defer all tax until death, when the estate might be taxed at 50 per cent or more, Don Forbes says. A gradual approach with payment of annual taxes as farm assets are disposed of is flexible, unlike a one-time “sell and retire” decision with hefty tax consequences.
The entire farm has gained value since acquisition. The capital gain will be offset by the $1 million Personally Owned Farm Land Capital Gains exemption for which Harry and Linda are each eligible. There is also $200,000 exemption for their primary residence and one acre.
There is a question of which assets should go to the children. The package of assets would include current book value plus the $2.2 million capital gains exemptions for farmland and the farm house and extra acre. Any remaining taxable gain balance would be deferred to the future owner through a lower deemed purchase price. This process will create a tax-free transfer of farm assets to the children.
The transfer process can be protected by having Harry and Linda take back a zero per cent interest promissory note on the land. This would protect the asset should either child have financial difficulties from insolvency or divorce. Creditors or an estranged spouse could seek the value of assets, but would have to pay out the parents before claims would be considered, Don Forbes explains. This way, the children get title to the land but the parents have effective control.
One solution to this tax dilemma is to pass all investment or rental income through the company to shareholders as bonuses, Don Forbes explains. These bonuses would create income spikes. If Linda has a good year with a salary over $90,000 she can use RRSP space to shelter a bonus. If there are no income spikes, RRSP contribution space can be saved, to use if there is a sale of farm assets at prices that recapture depreciation, Don Forbes advises.
Harry and Linda have an estate with a current value of $5.94 million. Assuming that they retire in four years, their RRSPs, with a present combined value of $244,820 (assuming no further contributions), would grow at four per cent after inflation to $286,000 and provide an annual annuitized Registered Retirement Income Fund flow for 30 years of $13,600 per year ($1,133 per month).
Neither Harry nor Linda have Tax-Free Savings Accounts. If they establish them now, each can contribute $63,500 for 2019 and add $6,000 per year in subsequent years. This would give them $240,000 by 2025. These accounts can be maintained for any future use or emergency, and can take in funds from sales of farmland after use of various tax shelters.
Linda will be eligible for a job pension of $2,360 per month to age 60 and then $2,010 per month thereafter. Each can take Canada Pension Plan benefits as early as 60, take increased values by delaying the CPP start. Both are eligible for full Old Age Security benefits at age 65.
If they retire at 65, they would have Linda’s job pension of $24,120 per year, two OAS benefits of $7,290 per year (at present rates this would be fully clawed back), plus estimated CPP for Harry of $5,880 per year, for Linda at $9,600 per year, as well as potential RRIF income of $13,600 per year combined. If they choose the second option, — keeping farmland that provides a rental income of $57,600 per year, after corporate-owned farmland is sold and proceeds of $1,906,000 invested — if all this money were paid out each year, the taxes would be onerous. It is better to have the corporation pay bonuses of $72,000 per year each to Harry and to Linda for the next 30 years with this plan.
The sum, $254,800, split and taxed at an average 30 per cent and excluding TFSA proceeds conserved for emergencies would be $178,360 per year. Their living expenses would be $60,00 per year if they stay on the farm, so they would have a large surplus, Erik Forbes explains.
“The second option is the best for the couple, for it allows flexibility and the opportunity to welcome the children to the farm if they choose,” Don Forbes concludes.