A new interpretation of the farm rollover rules has been giving Merle Good heartburn since the Canada Revenue Agency came out with it in June.
“That’s the one that scares the hell out of me,” the farm succession expert said at a recent Alberta Canola Powering Your Profits event.
“The rollover allows us to transfer land to the next generation without incurring tax, and I believe that’s going to be changed someday.”
In 1996, the Canada Revenue Agency adjusted the farm rollover rules so that farmers could transfer land to their children without incurring taxes on it as long as they — or someone in their immediate family (such as a spouse or a parent) — farmed the land for more years than they rented it out.
“I could even look up the family chain if I received it from Dad and add his time to my time,” said Good. “I could rent it out today for 42 years on cash rent and still qualify for the rollover.”
And once the child received it, they didn’t actually have to actively farm the land, he added. “You could leave your favourite quarter section to your daughter who’s married to a liberal in Ontario. I don’t know why you would, but you could.”
In June, though, the Canada Revenue Agency came out with a new interpretation of the rules, where only the individual farmer’s ownership period counts — he or she may not be able to combine their time with their parent’s or their spouse’s. During that ownership period, the land would still qualify for the rollover if it is farmed by a family member (a spouse or a child) for longer than it is rented out to a non-family member.
In 99 per cent of the cases, this new interpretation of the rule won’t be a problem, as most farmers farm their own land, said Good.
But in a case where, say, a husband farmed the land for 50 years and gave it to his wife upon his death, and she rented it out, she may no longer qualify for the rollover.
“If you’ve farmed Mabel’s land for the last 25 years as a renter, Mabel may not qualify for the rollover anymore,” said Good.
But even if this won’t cause a problem on the majority of farms, Good believes farmers should be proactive about talking to their lawyers about it now so they don’t get caught by it in the future.
“Your lawyer will say, ‘Don’t do a thing. The rollover rules will let you transfer all your wealth when you die, so don’t touch this until you’re dead.’ That’s called a chicken will — where we don’t do anything,” said Good.
“But my job is to take the will you want to have happen 25 years from now and try to enact some of it today.”
Life estates and remainderman interests
One of the ways farmers can do that is by transferring some of their land to their farming child while they’re still alive.
“It’s not a question of never transferring our land to our children,” said Good. “Otherwise we’d sell it all tomorrow. At a million bucks a quarter, what the hell are we doing here?
“But it’s a matter of when. We’re not worried about giving our land away. We’re worried about the three Ds — death, divorce, and debt. That’s what makes us nervous.”
Even so, if a farmer who has 10 quarters walks into Good’s office and tells him their 45-year-old child doesn’t own any land, he gets “grumpy.”
“What have we taught our sons and daughters is the most important thing in life? Owning land, but we won’t give it to them. It’s pretty frustrating.”
So Good has come up with a strategy that will allow farmers to transfer land to their farming child, while retaining some control and without burning up their capital gains exemption.
“If I sell my land to them for what they can afford to pay for it, it’s not much,” said Good.
“In Red Deer, it’s 40 per cent of fair market value divided by 20 years at no interest. That’s the number — it’s two times cash rent. That’s all they can afford to pay.”
In the past, parents might sell a quarter section at fair market value to their child, claim the capital gains deduction, and then not call the money in. Good describes that as: “I’ve burnt my exemption up, with no benefit.”
Instead, farmers should consider creating a life estate for themselves and a remainderman interest for their farming children, which allows the parents to keep control of and make income off the land even though the children own it.
“It allows the younger generation to do estate planning, but doesn’t take away what you guys want as parents, which is income and control,” said Good.
“I believe it’s a really neat mechanism for me to move ownership because I’m worried about the rollover rules, but still control the land.”
In property law, a remainderman is someone who is entitled to inherit property upon the termination of the owner’s life estate, which is the ownership of a piece of land until a person’s death. This effectively creates co-ownership of the land, where the life estate holder holds the right of access to the land and can draw income from it.
They do that not by charging rent for the land (which is taxable), but rather by selling the remainderman interest to their child over a period of time interest free, and then taking that money as a return of capital on a remainderman interest (which is tax free).
The remainderman actually owns the land and is granted access to it by the life estate holder. Upon the life estate holder’s death, the life estate expires. The remainderman simply needs to provide the death certificate to the land titles office, and the life estate holder is taken off the land title.
This gives the parents control and income during their lifetime, gives the child ownership of some land, and allows planning to be done now before any changes come to the tax rules.
“It’s a great idea tax-wise, but it’s even more important to see the next generation owning something,” said Good.
But it’s not for every quarter, he added.
“This is bare land I’m talking about, not home quarters,” said Good. “But I want you to look at it for maybe one or two quarters if you want to do some of this land transfer but still control the land.
“It’s very complicated, so talk to your lawyers about this. It’s powerful stuff.”