A couple we’ll call Max and Susan rent 320 acres to their son, who we’ll call Ernie, in central Manitoba. They are retired. Their problem is how to provide for their two daughters who do not farm. Worse, the retirement nest egg they put together years ago has been eroded by inflation and low returns on the GICs (guaranteed investment certificates) that make up a large part of their portfolio. Their operation is modest, but in structuring a transfer of their land and wealth to their children, they have a substantial advantage — they have no debts to settle.
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Nevertheless, Max and Susan need a new plan to transfer assets to their children. The Registered Retired Savings Plan (RRSP) converted to Registered Retirement Income Funds (RRIFs), which they expected to support them in retirement, have withered from $500,000 to just $50,000.
When they retired two decades ago, Ernie was to receive $800,000, the value of the land at the time, and the daughters were to get the proceeds of a $250,000 life insurance policy and an expected residual value in their RRIFs.
Max and Susan need $60,000 per year for retirement including travel expenses. They will have the advantage of a doubling in value of their land since the initial plan was created. But a cash crunch must be avoided.
The couple presented their dilemma to Colin Sabourin, an investment adviser and farm expert at Harbourfront Wealth Management in Winnipeg.
“The plan did not pan out exactly as the couple had hoped,” Sabourin explains. “The basis for their retirement now will be an estimated $22,000 rental stream from the land, $18,000 in combined Canada Pension Plan benefits, $15,000 in Old Age Security benefits and $15,000 per year from their Registered Retirement Income Fund. That adds up to $60,000 after tax and there is room upward for more income if asset returns should grow.”
The problem is taking $15,000 per year from their RRIFs will leave them with just about nothing in four years. Inflation, which has returned with a vengeance, is likely to raise their cost of living, forcing faster drawdowns of their RRIFs.
Years ago, when the couple created their retirement plan, Max and Susan expected to rent the land to Ernie, who would eventually inherit it. But now, given their need to sell the land, they must remodel their retirement strategy.
The new retirement plan will have to recognize the rising value of their land and wrap the value of land transferred in packages of present value and future value wrapped in a promissory note.
Instead of asking Ernie to pay $1,920,000 for the land, they can cut their asking price to $1,000,000. The paper value of the transaction would be a transfer at fair market value, estimated $1,920,000. Ernie would pay $1 million. The balance would be in the form of a promissory note forgivable when the last parent dies.
Ernie would get the land at today’s fair market value. It would increase the adjusted cost base of the land and so cut his capital gains exposure if he sells it. From the point of view of Max and Susan, the land sale at $1,920,000 will trigger a $1,520,000 capital gain. But that gain can be sheltered by Max and Susan’s unused capital gains exemption, Sabourin explains.
From Ernie’s point of view, the deal should be appealing for he will gain borrowing capacity in his $920,000 equity inheritance. That will help him in the future for buying equipment or even more land.
There will be some friction, Sabourin notes. First, Max and Susan will lose their Old Age Security for one year. They will have to pay about $100,000 for the Alternative Minimum Tax. They can recoup this over the following seven years because the AMT is effectively a prepayment of future taxes. They will be left with $900,000 cash.
They can put $81,500 of their cash into their Tax-Free Savings Accounts with the expectation that each person’s limit will rise by $6,000 in 2022. The remaining $737,000 will be left in a non-registered account. A portfolio of conservative stocks such as chartered banks that pay annual dividends of three to four per cent and have a history of long-term growth would fit their needs, the planner explains.
Any surplus from the farm value transferred to Ernie can be a gift to their daughters, who could add that to their $250,000 life insurance benefit, the farmhouse and whatever funds are left in the couple’s investment accounts. The life insurance benefit market value will decline with inflation, but that decline may be offset by the rising residual value of the off-farm investments.
The plan is robust in that it is simple, Sabourin explains. It is fair to Max and Susan for it provides the cash they will need in addition to CPP and OAS and their RRIF income. Ernie has a near-term addition of equity to his farm and the non-farming daughters will get cash over and above their insurance proceeds, Sabourin explains.
Max and Susan need to watch the value of the assets they are transferring. Diligent use of TFSAs, which provide for growth without further tax, can provide unimpaired asset growth, Sabourin emphasizes.
They and their accountants or advisors also need to ensure they use up the tax prepayment inherent in the Alternative Minimum Tax. They need to generate tax liability. Moreover, it must be done within the time allowed. After a taxpayer’s executors file a final return, if the AMT has not been recovered within the seven-year period that’s allowed, those prepaid taxes are gone forever, Sabourin notes.
