The Income Tax Act (ITA) provides a special deduction in computing the taxable income of an individual relating to a capital gain resulting from the disposition of a “qualified small business corporation share” or interests in qualifying farming and fishing properties.
This deduction can result in a maximum of $750,000 in capital gains being exempted from tax under the ITA (capital gains exemption). In the case of an individual resident in Alberta, the income tax savings resulting from the use of the capital gains exemption can be as high as $146,250.
This article will discuss using the capital gains exemption to reduce capital gains resulting upon dispositions of qualifying farm properties. My prior article discussed using the capital gains exemption in respect of dispositions of a qualified small business corporation share.
Types of properties eligible for the capital gains exemption
In order to qualify under the capital gains exemption, the capital property must be a qualifying farm property used in a farming business carried on in Canada, a share of a qualifying family farm corporation or a partnership interest in a qualifying family farm partnership (individually, a farm property).
Farm land and the capital gains exemption
In the case of a farm property that is farm land owned by an individual, the ITA requires that the individual satisfy a “gross revenue” test relating to the use of the farm land in the farming business in order to qualify for the capital gains exemption.
In some cases, this test will prevent an individual with alternate higher sources of income from accessing the capital gains exemption.
In other cases, if the farm land was last acquired prior to June 18, 1987, the capital gains exemption may be available by satisfying a less difficult test.
In yet other cases, proper structuring of the use of the farm land in a properly drafted and implemented farming partnership relationship may alleviate difficulties in satisfying the gross revenue test.
It may be possible to “piggyback” on a qualifying use of farm land by a parent of the owner, if the use of the farm land by the owner does not qualify for use of the capital gains exemption.
Use of the capital gains exemptions with the farm rollover rules
A couple of articles ago, I discussed the use of special set of rules in the ITA intended to facilitate a tax deferred “rollover” of qualifying farm properties from parents to their children (farm rollover rules). 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 capital gains exemption, which may be available in respect of qualifying farm properties.
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.
In the case of a testamentary transfer of a farm property (i.e., after the death of the parent), the ability to use the capital gains exemption is accomplished by making an appropriate tax election. However, in the case of an inter vivos transfer of farm property (i.e., during the life of the parent), no election mechanism is available to deem proceeds greater than the amount of consideration provided by the child. There are methods of properly addressing the absence of an election mechanism.
Internal use of the capital gains exemption
In the right circumstances, the capital gains exemption could be used to create a “pipeline” to access corporate earnings from a corporation without the incidence of dividend taxation.
Proper due diligence, advice and documentation is essential
Use of the capital gains exemption can avail significant tax savings for individuals disposing of farm properties. In order for individuals to properly avail themselves of the benefits of these rules, appropriate due diligence, tax advice and legal documentation should accompany use of this exemption.
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.