How To Manage Taxes And Benefit Clawbacks Late In Life

A widow we’ll call Alice, 83, lives on a farm of 600 acres in Alberta. Murray, Alice’s husband, passed away several years ago. The farm is no longer an active business, for Alice ceased working it in 2003 while they continued to live on the property. There is, nevertheless, modest farm income of $2,000 to $4,000 per year.

Alice’s three children aren’t interested in farming. She faces the inevitable necessity of selling the property, which has been in her family since 1953. She would like to make use of the $750,000 capital gains exemption for qualified farm property and perhaps to use it to eliminate tax on land the province expropriated last year for $377,000, which was paid with a $300,000 cheque in 2009 and will be paid with another for $77,000 in 2010.

Alice’s situation is understandable and, indeed, fairly common when farm businesses are fractured by death and lack of children to take over the farm. Her problem is serious and, given her age, needs an urgent solution.

Farm Financial Planner asked Don Forbes, head of Don Forbes &Associates Armstrong &Quaile in Carberry, Man., to work with Alice to find a solution to her twin problems of generational transfer or sale and tax minimization.

Alice does not have a lot of financial resources to invest in resolving her issues. Her customary annual income of $19,800 before the expropriation was made up of $6,204 in annual Old Age Security payments, Canada Pension Plan benefits of $4,200, Government of Alberta low-income supplementary payments of $3,000, $2,000 in farm rental income and $4,400 in interest income. She spends $18,000 per year.

SELLING THE FARM

Ordinarily, to be able to use the $750,000 lifetime capital gains exemption for qualified farm property, the land has to be actively farmed and the business must meet other tests. The general rule is that the property in question has been owned for at least two years before sale, that it has been used for farming on a regular and continuous basis, and that it be the most important income source for the owner. As well, it must be profitable for two years out of seven. However, for farms acquired before June 18, 1987, the profitability test does not apply. The rules apply equally to farm family trusts or to farm family partnerships. Family farm corporations may qualify under rules applicable to rules for Canadian-controlled private corporations, Forbes notes.

There may be doubt about the farm’s current operations, but it will clearly meet the test of ownership prior to June, 1987. And the sale of the 29 acres to the Government of Alberta for $377,000 in 2009 would be included in the amount that qualifies for the exemption, Forbes says.

When Alice’s husband passed away in 2003, his estate would have claimed the qualified farm property exemption for the limit at the time, $500,000. That $500,000 exemption plus Alice’s present $750,000 exemption will be enough to eliminate all ordinary tax on the property, which has an estimated value of $1 million, Forbes says.

TA XISSUES

There are still two problems, however. Alice has a tax bill for $17,000 on the sale of the expropriated farmland. That arises from a $374,000 capital gain on the land. She had an offsetting deduction for most of that gain via qualified farm property, but the Canada Revenue Agency will nevertheless generate an alternative minimum tax bill for $7,780.

There is another, more serious problem. The capital gain will trigger a 100 per cent Old Age Security clawback. It will also cause her to lose her age credit of $6,408, thus adding another $960 to her tax due to CRA. And the Alberta low-income supplement of $3,000 per year will also be lost. In effect, Alice’s windfall of $377,000 will wipe out all benefits. This is equitable in the sense that she has more money and thus needs less public support, but ironic in the sense that the sale was forced by expropriation. In her case, the government took her land, then took away her pension. Alice’s total tax cost triggered by the expropriation will therefore be about $17,000.

Next year, however, her taxable income will fall and she will regain OAS payments and eligibility for the age credit on her return. The low-income credit won’t be reinstated, for Alice will now have more income from the $377,000 land sale.

FUTURE ISSUES

None of Alice’s three children wants to farm, but she wants to give them a chance to retain the land in the family if they so wish. To do that, she should ensure that her will gives each of them a third of the farm, which each can retain. Alice will also have to decide how to invest her total liquid assets which, with the money from the expropriation, will add up to $500,000. At a reasonable six per cent income from a combination of stocks with strong dividends and bonds, she should be able to generate a $30,000 annual return which, with her pension income, will give her total income greater than she has had in the past. The income would be higher if she decides to sell some or all of the land rather than let her children inherit it.

Assuming that Alice retains the farm, her income, which spiked by $300,000 in 2009, will settle down to $130,000 in 2010 with inclusion of the $77,000 final payment, then decline. In 2011 she will have $29,000 of after-tax income and by the time she is 89, $34,000 after tax, Forbes predicts. Rising payments from Old Age Security and the Canada Pension Plan and a steady six per cent return from her investments will drive her growing income, he explains.

Those figures are in future dollars, so, in reality, Alice won’t necessarily be better off when she is 89 than she will be next year when she is able to invest the money from sale of some of her acreage to the province. Indeed, her expenses, driven by inflation, will rise from $18,000 today to $21,490 in 2016. The difference, of course, will be covered by higher income generated by the $377,000 she has received from the land sale, Forbes notes.

There is a wild card in these predictions. If Alice needs care later in her life, she will have to rely either on her children or on institutional resources. She should ensure that she has a will in place to execute her wishes for her land and an enduring power of attorney that directs her children or others to look after her financial affairs.

“We are looking at a late-life scenario which is about stability of income, not growth of assets,” Forbes says. “This is a case in which the person has few alternatives –either sell the family farm or hold it for eventual distribution. Alice is going to be a victim of tax laws, such as the OAS claw-back. It is unfortunate, but we have to plan around that problem. However, in the end, Alice is going to have more money to spend and more liquid capital than she has ever had before. That is the good news in this mix of tax law and personal circumstance.

“I have never had a lot of money and don’t need a lot,” Alice says. “There are problems, but I would like to stay where I am. I have a lovely yard and I get to see my children. There will be an adjustment, but it is a good thing. I plan to stay in my home and enjoy it as long as I can. And I am not just giving up on the loss of my Old Age Security and Alberta benefits. My lawyer is negotiating with the province for compensation for loss of my benefits through no fault of my own.”

AndrewAllentuck’slatestbook,WhenCanI Retire/PlanningYourFinancialLifeAfterWork, waspublishedin2009byVikingCanada

About the author

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Andrew Allentuck’s book, “Cherished Fortune: Build Your Portfolio Like Your Own Business,” written with co-author Benoit Poliquin, was recently published by Dundurn Press.

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