In north-central Manitoba, Linda is 75, recently widowed and wondering what to do with the family farm. She has 880 acres rented out for $1,500 per month for grain and pasture. Two sons in their 40s have off-farm jobs, but even if they wanted to go home and farm, there isn’t enough land for a successful operation. The problem is to ensure the financial viability of the farm for as long as Linda wants to live on it and to prepare the farm to be a financially viable entity when Linda wants to sell it or transfer it to her children. She also needs sufficient income to ensure that long life will not leave her in poverty.
For now, Linda wants to keep the farm and live on the yard site, to keep the farm in her family, and to prepare to transfer ownership to her children while protecting it from liability or loss. She wants to live independently on the farm, but she cannot farm it actively.
Farm Financial Planner asked Don Forbes and Erik Forbes of Forbes Wealth Management Ltd. in Carberry, Man., to work with Margaret.
Taxes and land values
The first problem is to deal with taxes on the estate. Linda and her late husband can offset any gains in the value of their personally owned and farmed land via the $1 million Personally Owned Farm Land Capital Gains Tax Exemption. Each partner is eligible for the exemption plus an acre of land around the farm house, Don Forbes notes.
Linda can transfer land to her children at any value between book and today’s market value. The best course is to use all available tax credits and tax exemptions to raise book value to the current market value before transferring farm land to her two adult children.
There are three values to be observed:
- Book value of the farm land. Purchased in 1972 for $5,000, it now has a large capital gain. Establishing that gain is an accounting question.
- Estimated current market value of farm land: $900,000.
- Current market value of the house and one acre: $100,000
It is important to select the right value for income tax payable when preparing the final return for Linda’s late husband. Given the transfer price of $1,000,000, Linda can subtract the value of her house, $100,000, the $5,000 value for the farm when acquired, and thus reduce the capital gain to $895,000. She can use the $1 million Farm Land Capital Gains Tax Exemption and thus wind up with zero federal tax payable, Erik Forbes says.
That is not the end of the story, for there will be two other federal taxes to pay. First, the OAS clawback which starts at $77,580. If Linda’s tax preparers for her late husband were to claim the entire gain for his final return, he would lose his Old Age Security for that year. If both Linda and her husband were to split the gain and each were to declare the tax on their respective returns, then both would lose OAS for that year.
The second tax to pay is the Alternative Minimum Tax, which will cause her late husband’s estate to have to pay tax due without the federal credits. The AMT would raise tax for the estate but it would not produce a useful carryforward for her husband to use in subsequent tax years. Obviously, there would be no future tax years for him.
There is more to do to protect the farm for future transfer. The title to the farm needs to be reregistered. Linda should work with her lawyer to take a life interest in the farm and her home.
That process will give her the right to occupy the property along with the requirement to receive the net income from the farm. Linda will continue to claim farm income on her personal income tax return, Don Forbes notes.
The life interest is not a deemed disposition, so no capital gains need to be declared or income tax by Linda. That’s why it is useful for Linda to use her late husband’s $1 million farmland tax credit.
This life interest terminates on Linda’s death and her children would then automatically inherit the farm. The land is valued and transferred at that time, with Linda’s farmland capital gains tax exemption used and all taxes paid.
Linda would receive Old Age Security, currently $607 per month, her Canada Pension Plan benefit of an estimated $483 per month, $567 from her Registered Retirement Income Fund, $1,500 per month land rent, for total income of $3,157. She would have income tax payable of $430, leaving net after tax income of $2,737 per month, Don Forbes estimates.
Linda’s expenses for living on the farm are speculative, but as shown in the chart, could total $2,000 per month, leaving a projected surplus of $737. That’s $8,844 per year, a significant sum for a person with no debts and little interest in buying a great deal.
The estate settlement process will result in a contribution to Linda’s RRSP, pushing it from its current value of $116,000 to $120,000. Her Tax-Free Savings Account, with a value last year of $7,000, will get a contribution of $8,650, so that, including the farm and financial assets will be about $1,155,650. She will have no debts, so her net worth including a two per cent adjustment for inflation and some tax due for the AMT will be $1,105,000.
That is a significant sum for a single person with no need to buy or rent a house, to furnish it, buy a new car in the near future or travel widely. Linda is healthy and her life expectancy a least another decade. Her financial problem, to keep as much of her farm as possible, is clearly settled. She will have sufficient cash and surplus income for a new car or a few trips.
Inflation will be a problem Her OAS and CPP income will be indexed, but it will be only 40 per cent of her total income. Her RRIF will pay an increasing fraction of its capital, but with the underlying investments in only interest-bearing instruments, the balance would be exhausted by her age 90.
It would be prudent to speak with a financial advisor to diversify her portfolio into assets which can pace inflation and remove the certainty that the good fortune of long life will not turn into the tragedy of an income, once sufficient but now not enough to sustain her modest way of life, Don Forbes says.