In western Manitoba, a couple we’ll call Jurgen, 73, and Frieda, 71, have farmed for the last 52 years. Jurgen inherited the home farm of 320 acres in 1972. The farm grew slowly. Jurgen and Frieda expanded the farming by renting land and buying parcels as they became available. At present, the couple has 2,000 acres of grain land. Of this, 1,200 is included in their farming corporation and 800 acres is held in their personal names.
Jurgen and Frieda have been successful. Their total estate has an approximate value of $3.7 million of which about $800,000 is off-farm financial assets in RRSPs, TFSAs and fully taxable investment accounts.
Recognizing that the time has come to plan a generational transfer to their son, Luke, 50, and daughter, Mary, 48, each of whom has a well-established off-farm career and no plan or wish to farm, they have considered including their grandson, Herb, 32, who has been doing much of the farm work for half a decade. He can take over the farm.
Jurgen and Frieda approached Don Forbes and Erik Forbes of Forbes Wealth Management Ltd. in Carberry, Manitoba for guidance in creating a financial plan for their grandson to take over farm management permanently while leaving shares to Mary and Luke.
There is a good deal of complexity in the transfer of interests, tax liability has to be considered. The goal is to keep average tax payable in a range of 26 to 33 per cent, rather than to defer as much tax as possible until the parents pass on. Taxes on the farm corporation if liquidated could be as much as 50 per cent. With planning, this potential tax rate can be reduced, Don Forbes says.
Tax management begins with application of the $1 million Personally Owned Farm Land Capital Gains exemption to which Jurgen and Frieda are each entitled. There is also an exemption for their primary residence and one acre with a value of $100,000. So the first $2.1 million of capital gains on the property and farmed land will be tax-free, Erik Forbes explains.
The farmland and farm assets can be transferred to the next generation or grandchildren at any price between book value and today’s market value, Don Forbes says. That would include all farmland, equipment and inventory. The goal is to use up all tax credits and tax exemptions while avoiding claiming full market value on the entire farm and having to pay all taxes due on the date of transfer.
The asset transfer would be priced at current book value plus $2.1 million capital gains exemption. Any remaining taxable gain could be deferred to the future owner through a lower purchase price. The result would be a tax-free transfer of farming assets to Luke and Mary. Jurgen and Frieda can take back a zero per cent interest promissory note on the land. That would protect the farm if the grandson, who will run the farm, were to get into problems with debt or divorce. Creditors or an estranged spouse could pursue the farm for the value of its assets, but they would have to pay off the promissory note first, Don Forbes says. This process results in giving full title to the grandson while maintaining control for retirement income.
The farming corporation is more complex. As a family farming corporation, it permits the shares held by Jurgen and Frieda to be transferred to grandson Herb at any price between book value and today’s market value. Any deficiency in value and tax due would be assumed by the new owner.
There is an alternative: have the farm classified as an investment holding company. Normal business estate rules would apply to the company, Don Forbes says. On death of the owners, their shares would be value at current market value and relevant taxes paid. Redemption of preferred shares would be treated as taxable dividends when received by the shareholder. If redeemed all at once, then a 40 per cent tax rate would be likely to apply.
Using a valuation from December 31, 2015, if the farm’s retained earnings are $385,000 and preferred shares have a value of $661,000, then the 40 per cent tax (on the total of these figures) would be $418,000 leaving $628,000 after tax. In this case, shares of the farm corporation would be transferred to the next generation at book value. An estate freeze that locks the equity value of common shares into fixed price preferred shares would allow the grandson, Herb, to get the common shares at a nominal cost. The future increase in the equity value of the farming corporation would go to Herb while the parents’ value would remain locked in the preferred shares, Erik Forbes explains.
The parents’ lawyer and accountant can do this reorganization into common and preferred shares with $600,000 converted into preferred shares. The remainder of the $628,000, likely very little after professional fees and related costs, would be common shares for Herb.
For 2017 and future years, the parents would redeem $30,000 of preferred shares rather than receive salary income. The redemption would be taxed as dividend income. If the parents live another 20 years, their equity in the farm would have been reduced and Herb’s equity in the farm would rise. They could transfer the personally owned home quarter to Herb so that he has a place to live. More land can be transferred to him in future, Don Forbes suggests.
Before the values of the farm and the farming corporation are crystallized in the transfer process, Jurgen and Frieda should add to their Tax-Free Savings Accounts. At present, they have about $32,400 of the allowable $104,000 combined limit in 2017. If they each top up their TFSAs and add $5,500 each year thereafter, they can have $120,000 each, including estimated appreciation, by 2025, Don Forbes estimates.
There is more to do with the couple’s off-farm financial assets. They hold an astonishing $715,000 in Guaranteed Investment Certificates at a local credit union. The principal is safe within the credit union central’s backing, but the returns are in low single digits, taxable, and unable to pace inflation. If Jurgen and Frieda assemble a portfolio of diversified off-farm financial assets, then the nearly three-quarter million deck of GICs would be able to generate gains and, given that capital gains and dividends are taxed at lower rates than interest, tax-efficient growth.
For now, Jurgen and Frieda can have a $5,200 monthly income before tax consisting of $578 each of Old Age Security payments, $500 Canada Pension Plan benefits for Jurgen and $350 for Frieda, farm dividends of $2,500 for Jurgen, and Registered Retirement Income Fund payouts of $700 a month for Frieda, all of which will add up to $5,206. The couple’s living expenses are just $3,000 a month, so they will have a surplus for saving, travel, gifts to their children or perhaps for donations to good causes.
“The process of going from Jurgen and Frieda’s operating farm to retirement with management and ownership held by the next generation is not really difficult, though it has several steps and some professional fees,” Don Forbes explains. “What we suggest is conservative and able to save taxes.”