Tax Considerations when using your Capital Gains Exemption on Qualified Farm Property
I am often asked by farming clients to provide tax advice when they are considering selling qualified farm lands. Most individuals believe there is an easy, one solution fits all, response but this is not the case. In fact the one thing that I would caution clients on, is that for decisions of this magnitude they need to visit their tax advisor
. With that out of the way I will try to outline some of the considerations.While the capital gain exemption may be available to fully offset the capital gain, remember that the capital gain is included in net income, and the exemption is deducted in calculating taxable income. Therefore, items that depend on net income such as benefits for children, provincial senior’s benefits and the clawback of Old Age Security could be affected. Alternative Minimum Tax (AMT) can also result when triggering a capital gains exemption. To avoid this result, you may wish to plan the transaction so that a capital gains reserve is available to reduce the amount of capital gain reported in the year by ensuring there are deferred proceeds. For example, a note payable due 30 days after demand vs. note payable on demand. No reserve is available on a sale to a controlled corporation. Always consider the impact of the Goods and Services Tax on any proposed transaction. In the case of shares, there may not be a significant concern. However, for the transfer of other property, you may wish to ensure the purchaser is a registrant for GST purposes before proceeding with any crystallization. The General Anti-Avoidance Rule (GAAR) is always a concern in tax planning. Information Circular 88-2 provides that the crystallization of a capital gain exemption is an avoidance transaction since it is undertaken primarily to achieve a tax benefit. However, it is not a misuse of the Act, nor is it an abuse with regard to the Act as a whole. Therefore the Canada Revenue Agency would not seek to apply GAAR to normal transactions undertaken to crystallize the capital gain exemption. Did a $100,000 capital gains election taint property for the purposes of the $800,000 capital gains election?
- If a taxpayer used the $100,000 capital gains election on their 1994 personal tax return on property that would have otherwise qualified for the $800,000 Capital Gain Exemption, the taxpayer should be aware that the election could affect his/her ability to claim the enhanced capital gains exemption in the future.
Use of the 1994 election resulted in a deemed sale and reacquisition of the property. Therefore, the farm property would have to meet the more stringent tests that apply for property acquired after June 17, 1987, to be eligible for the enhanced capital gains exemption in the future.
Some uncertainty also exists over whether a new 24-month "holding period" would also need to commence on February 22, 1994. Since the answer is not clear, one might try to meet the 24-month test after February 22, 1994, before attempting to trigger the $800,000 exemption.
- Can land be transferred to a company to crystallize the exemption followed by immediate transfer back out to the individual who owned the land originally?
A strategy followed by some taxpayers would be the sale of land to a company at fair market value for a note. The land would then be withdrawn by the individual from the company against the note payable. The hope would be that that land would now have a higher cost base as a result. It is very likely that the Canada Revenue Agency would find this type of transaction offensive and treat it as a sham or use the General Anti-Avoidance
Rule to remove the benefit of the transactions. In either case, the result would be no use of the exemption and no increase in the cost base.
Note, however, situations do occur where there are bona-fide reasons for land to be sold to a company and then sold back to the original seller. The company should then report a gain if the land value increased while held by the company (with no offsetting exemption). The Canada Revenue Agency should not be able to attack this type of transaction with the General Anti-Avoidance Rule.