A couple in central Manitoba – we’ll call them Harry, 59, and Susan, 60 — have built their eight-quarter farm over the last 30 years. It’s not incorporated. In all, the couple have 200 head of cattle. They have farmed successfully, but they have only one child, Luke, who is studying engineering. He has no interest in taking over the farm.
Harry and Susan want to keep the farm intact. Their solution is to convey it to their neighbours. As well, they want to help Luke pay off his tuition bills. They approached Nathan Heppner, a certified financial planner, and Erik Forbes, a registered financial planner, both of Forbes Wealth Management Ltd. at Carberry, Man., to develop a plan for transferring the farm to future ownership and management while ensuring the continuity of their retirement income.
Harry and Susan live modestly. They spend just $4,000 per month. They have no debts and want to continue living as they do now when retired.
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Their retirement assets total $780,000 composed of two tax-free savings accounts (TFSAs) with a total value of $280,000; Susan’s $75,000 RRSP; her $35,000 locked-in retirement account (LIRA); and $390,000 in non-registered investments. Assuming they can generate a 6.54 per cent rate of return and allowing for a 2.1 per cent rate of inflation and combining that cash flow with their Canada Pension Plan and Old Age Security benefits, they can make their target, Heppner estimates.
The more complex part of their dilemma is how to handle the generational transfer of their farm. However, sale for top dollar is not their concern. They will have sufficient funds for retirement, Forbes notes.
Let’s do the math. Harry and Susan bought their land for $1,115,000. The present total estimated value of their eight quarters is $3,840,000. If they can sell for that price, they could have a $2,725,000 capital gain. They have a lifetime capital gains exemption as follows:
- Market value: $3,840,000
- Book value: $1,115,000
- Capital gain: $2,725,000
Take off their combined lifetime capital gains exemption, $2,500,000, for a net capital gain of $225,000, and allow a 50 per cent inclusion rate. The result is taxable income of $112,500.
There are tax issues, Heppner notes. Canada has no estate tax, inheritance tax nor gift tax, but there is a tax liability on the $112,500 capital gain. Harry and Susan would gain nothing by selling the land to neighbours at less than fair market value. Any disposition of the land would leave the capital gain as a liability.
What to do?
If they gift the land to neighbours, there would be tax liability and payment would erode their retirement capital. If they gift the land at book value, they could not make use of their lifetime capital gains exemption. If they gift the land at less than fair market value, they would be double-taxed by the Canada Revenue Agency. And if they make use of an imaginative solution to defeat the Income Tax Act, CRA could apply the General Anti-Avoidance Rule and related penalties.
The planners recommend sale of the farmland to the neighbours at fair market value. That allows Harry and Susan to use their lifetime capital gains exemption. The neighbours lack cash for payment in full but Harry and Susan can use a vendor take-back via a promissory note for the full value of the land. The promissory note is a private mortgage on the land. It would have to be accompanied by a schedule of payments — say, $50,000 per year indefinitely. In a bad year, the agreement could allow for deferral of payment. When Harry and Susan have sufficient payments, they can elect to stop future payments or even cancel the loan.
There is flexibility in this plan. If the neighbours decide to sell the land, they would have to pay back anything outstanding on the loan. The administration of the loan would be in the hands of Harry and Susan. They could even draft a provision forgiving the loan when one or both die.
“The couple’s life of dedication and diligence has put them in a great financial position,” the planners explain. “They can achieve their retirement goals.”
