When a farm is sold as a going concern, it is fairly common for the family home to be situated on the same parcel of land and also form part of the sale transaction. An important consideration in these circumstances involves the allocation of proceeds between the farming assets and principal residence of the taxpayer. Absent this determination, the gain ultimately attributed to the residence may be subject to income tax or at the least utilize a portion of any available capital gains exemption (capped at $800,000 / individual) should the property be "qualified farm property."
To calculate the gain attributed to the farmer's residence, the Income Tax Act ("Act") generally provides two options. The first involves a "reasonable" allocation of proceeds and costs between the family home and remaining assets. If specific and identifiable costs are available, this may prove most accurate to establish a cost base for the family home. A review of recent sales data in connection with similar residential properties or an opinion of value from a knowledgeable real estate agent / broker should be sufficient to determine the proceeds of disposition allocatable to the residence.
The second option, by election, is accomplished by first calculating the gain on the entire transaction (i.e. the gain from the disposition of the land used in the farming business plus the gain on the principal residence portion). From here the Act allows a deduction of $1,000 plus $1,000 for each year after the later of December 31, 1971 or the date the residence was acquired and designated as the taxpayer's principal residence. The election should be filed by attaching a letter to the personal tax return of the individual detailing the following:
- that he is making the election;
- the number of taxation years ending after the acquisition date, which the property was his principal residence and during which he was a resident in Canada; and
- a description of the property sufficient to identify it with the property designated as his principal residence.
The decision regarding which option to select is primarily fact driven, and it would be prudent to calculate the taxable gains under both scenarios if the appropriate information is available.
Other important items to consider, which are beyond the scope of this article include any GST / HST implications and a determination of land / acreage that can be allocated to the principal residence.
Intergenerational Transfers – Planning Considerations
If it is desirable for the business related farmland and the principal residence to be gifted to a child, it is important the transaction be structured accordingly to take advantage of the exemption. Absent any planning, the assets (assuming they meet the requisite tests pursuant to subsection 73(3) of the Act) would likely still flow to the child on a tax free basis. However, this may result in an unexpected tax liability if ultimately sold by the child as he / she would inherit the historical cost base of the properties. One alternative would be for the transfer to be split into two separate transactions – one related to the residence and the other the business assets. This would allow the parents to trigger a FMV disposition on the residence, which would be sheltered by the exemption and further allow the child to inherit a higher initial cost base. The remaining assets can be gifted pursuant to subsection 73(3.1) without any imposition of tax.
There are a multitude of considerations when selling to a third party or transferring the family farm to the next generation. When a principal residence is involved, an additional element of complexity arises; and without proper planning, unexpected and oftentimes unnecessary tax may result.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
