In British Columbia, a widow we’ll call Martha, 51, has taken over five acres of farm land. The operation is small and dependent on rainfall, but was profitable before the expense of the installation of an irrigation system.
The single crop Martha raises, organic scallions, produced gross sales of $10,000 in 2010 on just half an acre of actual cultivation. It’s a terrific return for the land farmed, but in gross terms, it’s not much income for Martha. Her net worth, $851,000, is made up of her house and acreage ($550,000), $251,000 in RRSPs and $50,000 in personal assets. Her income is $10,000 gross per year from the scallions business and $5,400 per year from a Canada Pension Plan survivor’s benefit. The total of $15,400, does not cover her expenses, which run $18,000 per year.
There are other problems. The small acreage that Martha cultivates and her lack of success in making a profit together with the fact that the farm is not her principal source of income means that she can deduct no more than $7,500 of farm losses per year from other income. Moreover, just to keep this status, the farm must be profitable in two years out of seven. She is also at risk that the Canada Revenue Agency could reassess her if she does not meet that target. If she loses money for seven years in a row, that reassessment is likely to take place.
STAY OR SELL?
Martha’s financial dilemma is acute, for she must decide whether to sell the farm or make the farm generate more income. She might keep the farm and work off-farm to support it, or, if she can’t farm profitably or bring herself to sell, she might use her RRSP portfolio to generate an income of four per cent per year, $10,400, to get by.
Farm Financial Planner asked Don Forbes, head of Don Forbes &Associates/Armstrong &Quaile Associates Inc. of Carberry, Man., to work with Martha. In his view, she can avoid the hobby farm ruling if she shows that she is trying to be profitable. To do that, Forbes says, she must:
1.Have a separate chequing account for personal and farm expenses and income.
2.Divide expenses between farm costs and personal portions.
3.Keep comprehensive farm accounting records and a written farm budget. The aim is to show an intent to make a profit each year, even if that did not happen.
4.Buy higher capacity machinery that would allow more timely cultivation.
5.Take steps to show that the basic farm was profitable, but that adding capacity cuts returns.
Martha might be able to do more and move into the status of qualified farmer. That would require her to manage the land actively, which she already does, derive most of her income from the farm, as she can do, be profitable for two our of seven consecutive years and be a resident of Canada. If Martha does meet all of these tests, she will be eligible for the $750,000 Qualified Farm Property Capital Gains Tax Credit. She did add significant value to her farm by irrigating it. The goal of getting full value out of the farm with no significant tax payable is attainable, Forbes says.
Martha should expand her main crop, organic scallions, from half an acre to two acres. The remaining acres of her operation can be reserved for cover crops, crop rotation, and so forth. That step alone would increase her gross sales from $10,000 to a range of $30,000 to $40,000. If half the gross sales are needed for expenses, then Martha’s net income from the operation would rise to $15,000 to $20,000 per year.
Selling into the wholesale market is not the way to maximize revenue, either. Organic scallions are a premium product. Martha could capture more income by selling directly to consumers at retail prices via a website. Web designers are easy to find and easy to hire.
Martha should investigate what web sales could bring her, Forbes says. She could also add to storage capacity so that sales can be maintained year round.
In financial terms, Martha needs to expand her borrowing capacity. That will be essential to investing in more farm equipment, for example. She has a good deal of equity but no operating capital, Forbes notes. So her first step should be to get a secured line of credit with a linked credit card that will automatically pay interest due by the due date. Most financial institutions can make this arrangement.
Martha also needs to develop a farm business plan with a budget that will allow her make a profit. An agriculture extension office could supply model plans and help her with production numbers.
Martha’s mutual funds are inappropriate. She has 85 per cent of her RRSP capital invested in high risk, aggressive mutual funds in gold and other precious metals and resources such as energy. She should migrate the funds to blue chip companies that pay dividends and to bonds that will generate dependable retirement income.
If Martha cannot make her scallion farm profitable, she can accept hobby farm status with all of its limitations and just enjoy her house and land with a big garden. She would have to adjust her lifestyle expenses and seek off-farm employment. The bottom line is what Martha is willing to do to make her few acres profitable. If she can do that, she might begin to expand the operation as well.
THE FALLBACK PLAN
If this is Martha’s course, then she will have to begin adding to her income by taking money from her RRSPs. Allowing a $12,000 annual withdrawal rate, which would be sustainable to age 68, and then raised withdrawals gradually to $20,000 at her age 72, her money would last to her age 100.
On this basis, her total income, excluding any farming income, would be $12,000 from RRSPs, $54,400 from the CPP survivor’s benefit and $6,291 from Old Age Security in 2011 — a total of $23,691. By the time she is 72, her survivor’s benefit would have converted to a direct Canada Pension Plan benefit of at least $5,400, her RRSP withdrawals would have risen to $20,709, and OAS would be $6,291 for total income of $32,400. All figures are in 2011 dollars.
Martha’s fate as a farmer is really in her own hands, Forbes says. “She has the capacity and the means to grow her farm and to generate a much higher income from it. But she is not ready in a personal sense to leverage her equity and make aggressive moves to expand into a profitable farm. In time, that may change. My analysis shows what she will have if she does nothing. But if she did no more than raise eight times her current crop of scallions, her income from farming would be $80,000 less expenses and those expenses would, of course, tend to fall on a per bushel basis with higher volume. No one can tell Martha what she should do, but the opportunity of what she can do is clear.”
AndrewAllentuck’slatestbook,WhenCan IRetire?PlanningYourFinancialLifeAfter Work,hasbeenrepublishedbyPenguin Canadainarevisedpaperbackedition
She can generate income by selling directly
to consumers at retail prices