A couple we’ll call Jack and Mary Walrosser, 35 and 34, used to farm with Jack’s family in central Manitoba. Jack’s father Harold and Harold’s wife Beatrice, both age 61, farm 960 acres of pasture and oilseeds.
Life has had its challenges. Harold had contracts to produce pregnant mare’s urine for the pharmaceutical industry. Those contracts were terminated, but he had enough capital to retire and rent out his land. Land rents now form a large part of his family income.
Harold has watched his farm grow in value with the rise of land prices. Jack and Mary now live in town with their two pre-school children. They hold off-farm jobs that pay $100,000 in total. They have been saving to pay down the $120,000 mortgage on their $200,000 house.
Harold and Beatrice want to leave their property to Jack. The goal is to preserve the family farmland, its present value of $960,000 and the parents’ income stream.
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The ideal plan would be to transfer property titles to Jack in recognition of his former work on the family farm, while maintaining Harold’s income. Harold approach Don and Erik Forbes of Don Forbes Associates/Armstrong & Quaile Ltd. in Carberry, Manitoba, for estate planning and tax advice.
Under the plan they formed, Harold and Beatrice would transfer farm property to Jack at fair market value. The parents would claim the capital gain, apply for the capital gains exemption, and then raise the farm’s book value to market value virtually tax free. This would allow Jack a higher cost base — he can avoid paying capital gains tax on the initial value of the farm.
Harold and his wife want the rental income from the land; they should use a rent-to-own plan. Title would transfer to Jack now, with Jack making a commitment to pass the rental income less land tax costs to his parents. Jack would have no taxable income; the parents would declare the entire taxable portion of income.
Harold should take back a zero interest note for the full value of the land with a full repaid clause in the unlikely event of a breakup of Jack and Mary’s marriage, or bankruptcy. This will ensure that the parents have continuing access to the land rental cash flow while the son gets full ownership of the land and can capture rental income after his parents pass away.
If the property is transferred from Harold to Jack in a single year, they would have to pay $5,200 of Alternative Minimum Tax even though, theoretically, the Qualified Farmland Capital Gain Tax Deduction provides an offset credit for the AMT due. If they transfer the property over a three-year period, they can reduce the AMT to zero. There may still be title transfer fees.
While the AMT is collected at the time of application of the farmland capital gains deduction, it is used as a credit against future taxes owing. It is a way of prepaying taxes for several years, Erik Forbes explains.
The parents will qualify for the farmland capital gains tax exemption. They farmed for more than 30 years before they switched to renting the land five years ago. Eligibility for the farmland capital gains exemption is based on number of years farmed. After active farming, they have the same number of years to remain eligible for the exemption, Erik Forbes adds.
Jack should continue contributing $300 per month to his own RRSP, building up $400,000 by age 65. That sum, distributed with all capital and income, would provide $2,000 a month for the next three decades.
Jack and Mary already have a reserve of $30,000 in cash and term deposits. That money should go to a Tax-Free Savings Account, split evenly to take advantage of $31,000 of total accumulated TFSA space since 2009 when the program began. They can get a better rate of return if they use dividend-paying stocks in a low fee mutual fund or exchange traded fund.
In retirement, Mary will have a defined benefit pension plan that will pay her $2,482 at age 65 or $1,810 a month at age 60. Jack expects no company pension.
Jack and Mary have unfunded liabilities. If one or both of them were to die, their young children would require care. It would be appropriate for them to buy a $500,000 joint first to die term insurance policy for 10 years to supplement employer-provided insurance and eliminate the need to pay for expensive mortgage life insurance from their bank. If they have their own life insurance, then as the sum of their mortgage debt falls, they will have more cash leftover for the survivor’s and the children’s needs.
This plan will meet the family’s needs, but it is complex. On balance, the two generation family will have created a structure of ownership and money management that can survive for the next generation.