This article was originally published on July 12, 2018 and has been updated.
As a farmer, buying or selling farmland is an important decision, one that will have a significant impact on farming operations and economic success. Your key to success is one that positions you well toward reducing future tax liabilities and improving your financial outcome. An advisor can help you map out an optimal business structure.
When buying or selling farmland, prior to meeting with an advisor, consider the following questions:
IF THE SALE IS PART OF A RETIREMENT PLAN, HAVE YOU CONSIDERED ALL YOUR OPTIONS?
As you approach retirement, ask yourself if selling is the most advantageous action for your cash flow and retirement needs. Where no succession plan exists, we sometimes see farmers selling farmland as part of a retirement plan. Certainly, such a sale creates extra cash flow that can fund retirement; however, renting the land may be equally feasible. If a farmer decides to rent the farmland and use the rental income for living expenses in retirement, this may beget more after-tax revenue when compared to investing the money from the sale once taxes have been paid. However, if you are renting out the land for a longer duration, bear in mind this may affect the use of the capital gains exemption.
DO YOU UNDERSTAND THE TAX IMPLICATIONS AND TAX STRATEGIES THAT CAN MINIMIZE THE TAX BURDEN?
Before selling farmland, there are a few tax-related items to ascertain. First, is the property in question qualified farm property eligible for the capital gains exemption? Only individual taxpayers can apply the exemption on the proceeds from the sale of the sole asset. In addition, if the land is held personally, keep in mind that both the Old Age Security (OAS) clawback and alternative minimum tax (AMT) may be triggered on the sale. Plan appropriately.
WHO WILL BE PAYING THE TAXES?
Different tax implications apply depending on who has title and beneficial ownership. Depending on who purchases the farmland, title is delegated to a partnership, an individual or a corporation. In our experience, some farmers who hold land as a personal asset and add their spouse on the title believe that he or she is then responsible for half of the tax burden and that the spouse’s capital gains exemption can be applied to mitigate taxes. However, without beneficial ownership, the farmer may be unable to split or decrease the tax bill with their spouse, which leads to ambiguity regarding who is actually selling the property. Is it the one spouse, the corporation or is it held jointly? Make sure you know the answers to these questions before you sell.
HOW CAN YOU MITIGATE TAX CONSEQUENCES OF SALE?
RRSPs can be a beneficial consideration in the year of a sale, allowing you to mitigate the overall tax at the time of sale and defer some of the tax over a period of time. Other tax strategies can help to minimize the tax consequences of selling farmland. These include the following:
- Utilize the capital gains reserve, if applicable
- Time the sale properly
In certain circumstances where you receive payment for the sale over time, it is possible to claim the capital gain over time by employing the capital gains reserve. This strategy may also be beneficial to managing your AMT and OAS clawback implications. In addition, when you stagger payments from the sale over even two years – December 31, 2020, and January 1, 2021, as an example – this will decrease the capital gain inclusion each year, which in most cases saves tax.
DOES THIS PURCHASE ALIGN STRATEGICALLY WITH YOUR LONG-TERM FARMING PLAN?
Before moving forward with a farmland purchase, ask yourself if it makes good business sense in your farming operations. A financial plan, including the timeline required to recoup the investment, is essential. Without considering the key financial and long-term implications, many farmers believe owning more land is the best way to grow their operations. But individual circumstances are key. Is increasing your land base a good way to grow your business? You need to speak to someone who understands the related issues and can steer you in the right direction.
HOW DO YOU INTEND TO PAY FOR THE PURCHASE?
Alternative financing avenues may serve you well in lieu of cash payments, as it supports your future cash flow. Using cash to buy land impacts your liquidity and in turn your ability to respond to the unexpected. This can adversely affect your farming operations. Financing, on the other hand, allows you to keep some working capital for increasing your herd, completing repairs or purchasing necessary crop inputs while deducting interest payments in the farming business. Financing arrangements need to be flexible and adopted to seasonality implications of the agriculture industry.
WHAT IS THE BEST WAY TO HOLD THE TITLE?
Whether you wonder if you should hold the title as a personal asset, jointly with a spouse or in the farming corporation, there is no one right answer. However, one key consideration is your ability to access the capital gains exemption in the future. Structuring any land purchase effectively from the get-go allows you to prepare for succession planning, including the intricacies of the tax-free rollover rules for ensuing generations, and save significant costs and potential tax liabilities.
IS IT A GOOD DEAL?
Do you know the boundaries and acreage of the land in question? Has the local municipality annexed any of it previously? Does it have good access? Does it have any easements that could cause difficulties in the future? While most farmers understand regional market rates, in our practice, we often find farmers do not spend enough time on municipal and county regulations that may affect their purchase, including property surveys or title research. Issues such as these need to factor prominently in your purchase decision.