Selling your farm is supposed to be tax free, right? At least
the first $800,000. So why is that not always the case, and what
can you do about it?
What is alternative minimum tax?
The alternative minimum tax (AMT) is an alternative way to
calculate taxes owing in Canada when an individual experiences
preferential tax deductions. It was brought into effect to guard
against situations in which high-earning individuals might be in a
position to pay little or no tax by using certain deductions or
"tax preferences" to reduce a large portion of their
income. There is a "minimum tax" the Canada Revenue
Agency wants individuals to pay when using these tax
Thus, there is the typical way of calculating taxes, which
considers the special tax deductions and credits such as the
lifetime capital gains exemption, and there is this alternative
method. The typical way will usually result in more tax owing. But
when the second calculation results in higher taxes, the higher
amount – the AMT – will apply.
When does AMT arise?
For farmers, the AMT often is associated with the lifetime
capital gains exemption. The impact can be substantial on retiring
farmers selling their businesses and incurring sizable capital
gains in a tax year. Farmers subject to AMT should consider
treating it as a tax installment or prepayment because they can
recover the AMT amount to offset future taxes within seven
subsequent years. Thus, individuals with no taxable income in
subsequent years will forego the opportunity to recover AMT.
For example, a farmer who uses the $800,000 lifetime capital
gains exemption on the sale of qualified farm property would owe
$25,000 to $48,000 in taxes, depending on the province of
residence. This can be a significant amount and can affect cash
flows, particularly if the capital gains exemption was triggered on
Minimize and plan for AMT
There are two key strategies to minimize and plan for the cost
Carrying forward net capital losses –
Individuals should obtain their most recent notice of assessment to
confirm they are using up all capital loss carry forwards. These
capital losses can be carried forward indefinitely and can be
applied to reduce taxable income and thus reduce the capital gains
exemption, which will lower AMT. However, if an individual locks in
the capital gains exemption on qualified farm property and plans to
use the full $800,000, this will not reduce AMT. Carrying forward
capital losses in essence simply increases the cost base of the
property rolled over, as the intention is to use the full
Using a reserve on the sale of qualified farm
property – A reserve will allow for a deferral of
the capital gain, resulting in less minimum tax each year. A
reserve may only be used if a portion of the consideration on the
sale remains outstanding. Typically, this occurs when part of the
consideration for the sale is a note payable. This strategy will
help smooth out the burden of the minimum tax, as any other taxable
income in those years will help recover the AMT. The reserve will
also help extend the period for which the AMT can be recovered; the
seven-year clock starts running when AMT is incurred.
Getting AMT back
In the years after using the capital gains exemption,
individuals will want to recover AMT by having adequate taxable
income. An individual who has limited taxable income in subsequent
years may not recover all of the AMT paid, which will then result
in a true cost upon disposition of qualified farm property. This is
when the true "evil" of AMT becomes apparent.
Depending on the individual's situation, there are many tax
planning strategies that can help to recover the AMT. For example,
a farmer who operates through a corporation and usually receives
dividends as compensation could convert to a salary structure,
which would increase tax at the individual level and provide more
opportunity to use up the minimum tax. In addition, realizing
capital gains in non-registered accounts or withdrawing RRSPs in
years of low income can generate taxable income that can be offset
by the AMT balance.
Be prudent and seek help when necessary
The rules governing capital gains and the use of the capital
gains deduction are complex. The purpose of this article is simply
to remind farmers of the two-tax system. If you are considering
business management activities that could trigger a capital gain,
it is wise to have a Collins Barrow adviser and a financial planner
on your management team.
Most importantly, give yourself time to plan, since time will
increase your options when it comes to minimizing the tax
consequences. The tax law, as it relates to taxable capital gains
and the AMT, does have an upside: increasing the potential returns
and advantages of good planning.
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.
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