The general rules in the Canadian Income Tax Act provide that if a parent sells, gifts or otherwise disposes of a property to his or her children, the parent will dispose, or be deemed to have disposed, of the property for proceeds of disposition equal to the fair market value of the property.
These general rules apply regardless of whether the disposition occurs during the parent’s lifetime or after the parent’s death pursuant to the terms of his or her will.
In many cases, the application of these rules will result in Canadian income tax liabilities for the parent.
One important exception to these general rules relates to a special set of rules in the Income Tax Act intended to facilitate a tax deferred “rollover” of qualifying farm properties from parents to their children (farm rollover rules).
Some farm properties, including farm land in Alberta, have appreciated significantly in parents’ hands and absent the availability of the farm rollover rules, the parent or the parent’s estate may incur significant Canadian income tax liabilities upon transferring farm properties to his or her children.
Types of properties eligible for the farm rollover rules
In order to qualify under the farm rollover rules, the property must be qualifying farm property used principally in a farming business carried on in Canada in which a qualifying person (usually the parent) was actively engaged on a regular and continuous basis, or a share in a qualifying family farm corporation, or a partnership interest in a qualifying family farm partnership (individually, a “farm property”). The farm rollover rules have different technical requirements that must be satisfied depending on the type of farm property disposed of.
Application of the farm rollover rules
In general, the farm rollover rules operate to transfer a farm property at its “tax cost,” such that no gain or loss is realized by the parent and the child inherits the income tax attributes of the farm property to the parent. As a result, the child assumes the obligation for all the latent tax liability in the farm property.
Accordingly, these intergenerational transfers of farm properties are merely a deferral of income tax to the next generation, and not an absolute elimination of tax.
In some cases, it may be desirable to partially or wholly override the application of the farm rollover rules in order to utilize all or part of the parent’s $750,000 lifetime capital gains exemption, which may be available in respect of qualifying farm properties. (The capital gains exemption rules for qualifying farm properties will be discussed in greater detail in our next article.)
Use of the capital gains exemption in these cases may allow for a “bump up” of the tax cost of the farm property in the hands of the child, with little or no tax detriment to the parent.
Interestingly a farm property may qualify under the farm rollover rules but not under the capital gains exemption rules and vice-versa.
Further, the farm rollover rules can be overridden to the detriment of a parent transfer or if a child transferee seeks to use his or her own capital gains exemption on a subsequent disposition of the transferred farm property.
Proper advice from a qualified tax adviser can help avoid this potential pitfall.
Different farm rollover rules for inter vivos and testamentary dispositions
There are farm rollover rules that apply for testamentary dispositions (i.e., after the death of the parent) and other farm rollover rules for inter vivos dispositions (i.e., during the life of the parent).
While these rules are similar to each other, there are a few differences that may be important. Further, differing provisions in the Canadian Excise Tax Act for the application of the GST to these dispositions will need to be properly addressed.
Spin-off of family farm corporate assets
The farm rollover rules may be used in connection with a tax-deferred spin-off or “butterfly” of certain farming assets out of an existing family farm corporation into a new family farm corporation of which one or more of the children of the parent is a shareholder, while one or more of the other children of the parent is a shareholder of the existing family farm corporation, or another new family farm corporation.
In some cases, these corporate reorganizations will necessitate compliance with certain technical butterfly provisions in the Income Tax Act in order to implement the corporate reorganization on a tax-deferred basis.
In all cases, these reorganization transactions and related documents should be carefully and properly planned, drafted, and implemented by qualified tax advisers.
Proper due diligence, advice and documentation are essential
Use of the farm rollover rules singularly, or in conjunction with the capital gains exemption, can avail significant tax deferrals and savings for parents selling, gifting or otherwise disposing of farm properties to their children. In order for parents to properly avail themselves of the benefits of these rules, proper due diligence, tax advice, and legal documentation should accompany use of these rules.
Tax Talk appears on the first and third Tuesday of every month in the Business section of the Advocate. It is written by Jason Stephan, a chartered accountant and a tax lawyer who is tax counsel with Red Deer law firm Warren Sinclair LLP. Readers with specific tax issues are encouraged to consult a qualified tax professional for advice appropriate for their circumstances. Stephan can be contacted by email at firstname.lastname@example.org and by telephone at 403-343-3320.