In southern Manitoba, a couple we’ll call Ed and Barb, both 64, farm 900 acres of grain with some beef cattle. They have a son Ernie who is 40 years old. He farms and wants to take over Ed and Barb’s spread when they retire. A daughter, 38, who is married to another farmer, could pitch in, but has no great desire to do so. Another son, 40, lives in Winnipeg and has no desire to farm.
It’s a common dilemma. The parents have a legacy they want to preserve. They have the means — a son who will take over the farm — that allows transfer of ownership without selling to a stranger. But they also want to be fair to two children who prefer not to take over the farm business.
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Ed and Barb think they will need $60,000 per year after tax when they are retired for expenses and $15,000 for annual donations to their church. Their issue — how to transfer ownership of their spread to Ernie in a tax-efficient manner and have enough income to meet their goals.
Colin Sabourin, a certified financial planner at Harbourfront Wealth Management in Winnipeg, came up with a strategy for Ed and Barb. His goal — a tax-efficient plan to ensure the couple will have sufficient funds in retirement to meet their needs.
The foundation for a wealth transfer to their children is already in place. The couple did a corporate estate freeze when Ernie joined the farming corporation three years ago. The corporate structure provides $858,000 of preferred shares and $52,800 at today’s value common shares to the couple.
As well, Ed and Barb own personal farmland worth $3,735,000 with an adjusted cost base of $716,000. Their embedded gain is $3,019,000. Ed and Barb each have their $1 million capital gains exemption intact.
Ed and Barb have focused their lives and finances on the farm. They have only $50,000 in their Registered Retirement Savings Plan (RRSP). Most of the retirement income is going to have to come from Ernie when he takes over the farm. Ed expects $7,200 per year from the Canada Pension Plan (CPP) and Barb $6,729 per year. Each will be eligible for full Old Age Security (OAS) benefits, currently $7,380 per year. Given that they want to have $5,000 after tax and be able, in addition, to donate $15,000 per year or $1,250 per month, they are far behind their goals.
Ed and Barb also want to provide two parcels of land to their other children along with any remaining cash in their accounts after they die. All remaining farm assets will go to Ernie. The division of Ed and Barb’s assets is fair in concept and workable with goodwill on all sides, Sabourin notes.
Ed and Barb have been withdrawing $60,000 per year from their farming corporation. Ed is content to be a helping hand when Ernie takes over the farm. Moreover, the $15,000 annual donations will generate tax relief. They can redeem preferred shares which, when sold, will be treated as dividend income on their tax returns.
Including CPP and OAS and the estimated return from their modest RRSPs, when converted to Registered Retirement Income Funds (RRIFs) at age 71 with payouts beginning at age 72, Ed will have taxable income of about $39,580 and Barb taxable income of about $39,100. They would have combined taxes due of $8,180, Sabourin estimates. However, $15,000 donations to charity will reduce taxes owing to $4,130 per year.
Assuming they have $79,160 cash flow and pay $4,130 tax, they will have a net income of $75,030. That will provide the $5,000 per month or $60,000 per year income they want for retirement.
The couple’s goal is to transfer the farm to Ernie. They can sell enough farmland to their son to generate a $2 million capital gain, which they can offset with the lifetime capital gains exemption of $1 million per person. They would receive a promissory note from their son in lieu of payment. They could forgive that note at the death of the second partner. This process would achieve their goal of gifting the farmland while also taking advantage of their capital gains exemption for increase of the land’s value to $2 million. The remaining land can be gifted over time as they wish, either to their children or, perhaps, subject to valuations, to the causes to which they want to give $15,000 per year. The resulting adjusted cost base will flow to their children. If the farmland is sold in future, the children can use their capital gains exemptions, for it will be qualified farm property transferred in this plan.
Alternatively, and also a simpler plan, Ed and Barb could arrange for Ernie to pay them $3,860 per month. Split for tax purposes, the payments would be tax-free but given the couple’s donation plan to give $15,000 per year to charity, they could not make use of the resulting tax credit.
Eventually, Ed and Barb will run out of preferred shares to sell. At this point, they can sell farmland to Ernie. In lieu of mortgage payments, Ed and Barb could ask their son to pay them rent to farm the land they still own. That would create sufficient taxable income for donations to offset and recoup alternative minimum tax (AMT) when they sell chunks of farmland to Ernie. However, they could not recoup OAS forfeited to the clawback when they generate $79,845 or more taxable income in a given year.
The best plan is for the farm corporation to buy Ed and Barb’s preferred shares. If they spend less, perhaps by travelling less or by reducing other allocations, they can reduce what they ask for from Ernie.
This plan is simple, workable and easily amended if one of the other children wants to stay on the family farm as an owner. The operating mechanism is share capital that is easily shuffled.
The remaining risk is a marital breakup or personal insolvency that could require sale of some farm assets transferred to any of the children. That possibility can be covered with a demand loan secured by the share of farm assets to each child allowing the parents to take back any land or farm assets that might be seized in any legal action. That is fair to the parents and to the other siblings.
“This is a simple plan that should work for the parents and the children,” Sabourin concludes.
