Farm succession planning is complex. The transition of the family farm to the next generation raises several considerations, with one of the most important being how to transfer the farm in the most tax efficient way, both for the parents who are transitioning out of the farm and the child(ren) that are taking over the farm. One important consideration in succession and estate planning is the Capital Gains Exemption (“CGE”) rules in the Income Tax Act (Canada) (the “Act”). If applicable, these rules may create beneficial tax results when a person transfers farm property, such as farmland, or shares of a farming corporation, to their child(ren). For the purposes of this article, the focus will be directed specifically to farmland and the implications of the CGE rules upon the death of an individual.
Consider a situation where you have two children that both wish to continue farming. You provide in your Will that upon your death, all of your farmland, which includes 10 parcels, will be transferred to your children as joint tenants. This is sometimes done with the best intentions – to keep the family farm together. However, there are important tax considerations as to why this may not be the best option.
With respect to the CGE, the Act allows individual taxpayers resident in Canada to claim the CGE in respect of capital gains realized on the disposition of qualified farm property (“QFP”). In order for farmland to be QFP, it must meet stringent conditions regarding the owner of the property, the user of the property, and the use of the property.
The ownership period of the farmland is relevant for the CGE. To qualify, it must have been owned throughout the period of at least 24 months immediately preceding the date of disposition by an eligible owner (the “ownership period”).
An eligible owner under the Act generally includes the individual, their spouse, their parents, their children, or a corporation, partnership, or trust of such individuals. Notably, an eligible owner does not include a sibling of the individual. It is therefore important that property be transferred in a direct lineal chain from parents to children (inclusive of spouses) or else the ownership period could be “reset”. This is important because other requirements (as shown below) can be satisfied at any time during the ownership period, including by prior owners of the farmland.
To qualify for the CGE, there is also a test with respect to the use of the farmland (the “use test”). In at least two years during the ownership period, the gross revenue of an eligible owner from the farm business must exceed their income from all other sources for that period. Also, during those same two years, the farmland must be used principally in a farming business carried on in Canada, and one or more of the eligible owners must be actively engaged in that business on a regular and continuous basis. In most situations, if one of the eligible owners actively farmed the land for at least two years, this test will be met, provided we always recommend getting the backup to verify the precise tests.
When applying the above to the situation where 10 parcels of farmland are transferred to the two children jointly upon the parent’s death, a potential problem could arise, notwithstanding that the parents have satisfied the “use test”. For example, the two children wish to separate their ownership of the farmland between them, and each child swaps their 1/2 interest in the farmland so that they each become the sole owner of 5 parcels of farmland. For the 1/2 interest which each child received from their sibling, the ownership period will be reset. Therefore, the child cannot rely on their parent’s “use” of the land to qualify for the CGE unless the child is also actively farming the land, in which case they can satisfy the “use test” on their own. If consideration is not given to a situation where a child will inherit farmland and will not be actively farming it, that child may lose the ability to claim the CGE with respect to the farmland they acquired from their sibling.
It is also noteworthy that for the purpose of these rules, “child” is expanded to grandchild and great grandchild. Due to this, if land passes directly from parents to children through multiple generations, a great grandchild who doesn’t even farm the land could potentially qualify for the CGE on the basis that the use test is satisfied by their great grandparent’s farming activities which occurred in the same continuous ownership period.
Currently, each individual taxpayer is entitled to a lifetime CGE of up to $1,016,836.00 on the disposition of QFP. The loss of the ability to claim the CGE on the farmland in the above example is therefore significant for both children.
The parents in the above example may have thought they were treating their children equally and not have realized the potential tax benefits which have been lost when transferring the farmland into the joint names of the children. This is why it is important to consider the CGE rules in the context of estate planning with the family farm.
As an important reminder, the CGE is only one of many considerations (tax and otherwise) in farm succession and estate planning. It is therefore critical to review your succession and estate planning with your team of advisors.
Gregory A. Kirzinger
STEVENSON HOOD THORNTON BEAUBIER LLP
500 – 123 2nd Avenue South, Saskatoon, SK S7K 7E6
Telephone: 306-244-0132
Email: gkirzinger@shtb-law.com
Kade Kehoe
STEVENSON HOOD THORNTON BEAUBIER LLP
500 – 123 2nd Avenue South, Saskatoon, SK S7K 7E6
Telephone: 306-244-0132
Email: kkehoe@shtb-law.com
This article is provided for general informational purposes only and does not constitute legal or other professional advice.
This article was originally published in The Western Producer on January 5, 2024.