|
|
Land
Lease Arrangements
 |
| Agdex#: |
812 |
| Publication Date: |
October
2001 |
| Order#: |
01-065 |
| Last Reviewed: |
October
2001 |
| History: |
Original Factsheet |
| Written by: |
R. W. Gamble - Finance and
Business Structures Program Lead/OMAFRA |
Table of Contents
- Introduction
- Section 1 The Elements of a Lease Agreement
- Section 2 Termination and Other Legal
Issues
- Section 3 Types of Leases
- Section 4 Tax Implications of Land Leases
- Related Links
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Introduction
Leasing and renting land is a common practice in rural
Ontario. The high capital cost of land makes leasing an attractive alternative
to ownership. There are both advantages and disadvantages to leasing farmland.
While reduced capital cost is an advantage, the difficulty of securing
long term leases on land is a disadvantage. Leasing
Advangates and Disadvantages summarizes some of the advantages and
disadvantages of leasing.
This Factsheet addresses the general issues that a landlord
and tenant should consider when entering into a leasing agreement. More
specific information on lease types and sample agreements is available
in the following Factsheets:
Section 1. The Elements of a Lease Agreement
The Human Dynamics of a Successful Lease - Can You Get Along?
Any form of business agreement requires a good deal of mutual respect
and trust. Leasing land is no different. To be successful the lease arrangement
must satisfy both the landlord and the tenant. Before entering into a
lease the landlord and the tenant should consider more than just price.
The compatibility of the landlord and the tenant and the fairness of the
lease are important aspects to consider. In Table 1
can you answer yes to the following questions?
Table 1. Checklist of a Successful Lease
| Characteristics |
Question |
Yes |
No |
|
Compatibility
|
Can you get along and discuss differences?
|
|
|
|
Honesty
|
Do you trust the person you're dealing
with? This is especially important in a crop share lease. |
|
|
|
Clarity
|
Do you both know the terms of the lease
and are they in writing? |
|
|
|
Equitable Terms
|
Are you both happy with the terms? |
|
|
|
Flexibility
|
Can you adjust the lease if changes occur?
|
|
|
|
Suitability
|
Does the lease fit the crop and encourage
good agricultural practices? |
|
|
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Should the Agreement be Verbal or Written?
In Ontario the majority of farm lease arrangements are simple verbal
agreements. The handshake is a long-standing method of doing business
in the rural community. While a verbal lease agreement is a valid contract,
it has disadvantages for leases of 3 years or less. Leases longer
than 3 years must be in writing to be a valid lease agreement. Many farmers
and landowners are reluctant to use a written lease for several reasons.
While these objections are valid they do not take into account the cost,
frustration and relationship damage a disagreement can cause. The disadvantage
of a verbal lease becomes apparent when a disagreement occurs. At that
point it is exceedingly difficult to prove what the terms were. At that
point the credibility of the parties becomes the deciding factor.
A written lease can prevent, or at least, minimize the risk of this.
A written agreement is not a sign of distrust - it shows that both parties
want a clear understanding of the agreement they are making.
Advantages of a Written Lease Agreement
A written lease is advantageous to both the landlord and the tenant since
it provides both with a record of what they have agreed to. In the case
of crop share leases, where the landlord and tenant are sharing costs,
this is especially important. A written lease:
-
clarifies the expectations and responsibilities of
both parties and if a dispute occurs it can prevent costly legal action
by providing for alternatives to a court proceeding
- gives the landlord some protection in the event of an environmental
liability
- provides a valuable guide to heirs if the landlord or tenant should
die
-
provides documentation for tax purposes.
What Information Should a Lease Contain?
A written lease can be as simple or detailed as the landlord and the
tenant wish. Table 2 presents the items that a lease can contain. These
are categorized under 3 headings:
-
Required - all leases must contain
this information
-
Recommended - items that every landlord
and tenant should consider including in the lease agreement
-
Optional - items that add clarity
to the lease agreement and provide discussion points for the landlord
and tenant as they formulate the lease agreement
Required Items
Names and Addresses of the Tenant and Landlord and
Spouses if required
Description of Property to Be Rented -
includes the common legal description and specifies buildings or areas
to be excluded.
The Term of the Lease - indicates
when it starts and how long it lasts and, although not a basic requirement
of a lease, this section should address the renewal of the lease if the
parties wish to maintain the lease agreement for a period of years. The
lease should also state when and how such a renewal will take place.
Rent Payable - what is the amount of rent,
how is it calculated and when it is to be paid.
Recommended Items
Right of Inspection and Removal of Crops
- Includes the following:
- the landlord should have the right at all times to inspect the rented
property
-
the tenant should be able complete harvesting of the
crop after termination of the lease agreement or the sale of the property.
If this is not possible the landlord will compensate the tenant for
the anticipated agreed value of the crop
-
the incoming tenant, purchaser or landlord should
have the right to enter on the land after harvest in the last year
of the agreement to prepare the land for next year's crop.
Transfer of Property - It is important that the landlord
and tenant discuss their expectations in the event that the landlord sells
the farm property to a new owner during the term of the lease. A fair
agreement will attempt to strike a a balance between the landlord's desire
to not unduly restrict their ability to sell the farm and the tenants
desire to continue the lease arrangement.
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Summary of Required, Recommended
and Optional Lease Items in Written Lease Agreements
Required Items
- names and addresses of tenant and landlord
- description of property to be rented
- term and renewal of the lease
- rent payable
Recommended Items
- right of inspection and removal of crops
- transfer of property
- termination of the lease
- the use of the land
- environment matters
- insurance
- rights to assign or sublet the lease
Optional Items
- aribitration of differences
- production practices and management decisions
- income support payments, subsidies and reimbursements
- compensation for repairs to buildings, fences, and improvements
- compensation for property damages
- rights of first refusal
- option to purchase
- municipal zoning restrictions
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Termination of the Lease -
the lease should clearly spell out how the lease can be terminated. This
could be due to a breach of the terms of the lease or merely because the
termination date of the lease has arrived.
The Use of the Land - the lease should
state how the tenant is going to use the land. The tenant should be required
to adhere to normal farming practices in regard to disposal of manure.
It should also be clearly stated how the land is to be left after termination
of the lease. If buildings are included in the leased property, the lease
should state how the buildings will be used and the rules for accessing
the buildings.
Environment Matters - This clause addresses
the issue of environmental policies and responsibilities. In the event
of an environmental problem the landlord, as owner of the lands, is ultimately
responsible for activities occurring on their land. The tenant, as "user"
of the lands, should agree they will adhere to appropriate and accepted
farm practices and legislation relating to the environment (manure disposal,
pesticide and herbicide applications etc.). The tenant should also provide
a "warranty" -a legal term meaning that this assurance can be
legally relied upon - that they possess the necessary provincial licenses
for the application of pesticides or other chemicals to be used on the
property.
The tenant should also agree to bear the cost, including
the costs associated with an environmental clean-up, and reimburse the
landlord for any costs that the landlord incurs as a result of the breach
by the tenant of any environmental regulation.
Insurance - A clause regarding insurance
would allow the landlord and tenant to identify who will be responsible
for insurance coverage. The parties should ensure adequate policies of
insurance coverage, including occupier's liability insurance (insurance
against personal injuries sustained by people coming onto the farm property)
and fire insurance (if buildings are included), are in place. For a complete
coverage of Insurance issues, including environmental issues, see OMAFRA
Factsheet Farm Business Insurance, Order No. 00-041.
Rights to Assign or Sublet the Lease - The
written agreement should contain a clause that prevents the tenant from
subletting or assigning the lease to another individual without the written
consent of the landlord. In a production lease the consent of the
landlord can be unreasonably withheld. In the case of a residence the
landlord cannot unreasonably withhold consent.
Optional Items
Resolving Differences - An arbitration
clause in the written agreement describes how to deal with disagreements
the tenant and landlord cannot resolve together. The most common practice
is to appoint a mutually agreed upon third party to act as arbitrator.
Production Practices and Management Decisions
- This clause deals with the issue of production and management decisions
the landlord wants carried out by the tenant. Some of those factors could
include:
- cropping decisions
-
use of fertilizer and chemicals
-
crop insurance and revenue insurance
-
delivery and sale of crop
Income Support Payments, Subsidies and Reimbursements
- the written agreement should clearly specify how government or marketing
agency payments will be divided. This is most relevant in a crop share
lease.
Compensation for Repairs to Buildings, Fences, and
Improvements - The agreement should state who is responsible
for repairing buildings, fences, and other improvements, and how the expenses
will be shared. A common practice is to have the tenant responsible for
all minor repairs and for the landlord to reimburse the tenant for improvement
costs that have a lasting benefit longer than the rental term.
Examples of major improvements that extend beyond the length
or termination of the lease are:
- building and fence construction
-
erosion control
-
tile drainage
-
clearing land
It is usually required that tenants obtain written permission
from the landlord before making major improvements. It is also important
to outline how the value of improvements will be determined and when compensation
will be made. One practice is for the landlord to let the tenant farm
the improved land rent-free for a specific period of time.
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Compensation for Property Damages - The
party who has suffered the loss should receive any compensation that is
payable. For example, if a payment is made as a result of crop damage,
the tenant should receive the entire compensation in the case of cash
rent. With a crop share lease, however, the compensation should be shared
in the same portion as the crop is shared. Both the landlord and tenant
must notify AGRICORP of the crop sharing arrangement. Where there is capital
damage to land, the landowner should receive the entire compensation.
Rights of First Refusal - in some
cases, the tenant is interested in purchasing the leased land but is either
unwilling or unable to do so at present. In these cases, the landlord
may be willing to include an option to the tenant to purchase the property
by matching the offer the landlord receives from a third party to purchase
the lands.
Option to Purchase - similar to
the Right of First Refusal, the parties may include an option that allows
the tenant to purchase the leased lands. This could be either a fixed
price or a price to be determined by some objective method such as a real
estate appraisal by a certified agricultural appraiser.
Miscellaneous - the lease agreement
may contain a clause that would terminate the lease if certain natural
disasters occurred. For example, if the land was flooded and the tenant
was unable to use the property, it would be unfair to insist the tenant
continue to pay the cash rental unless the original rent charged had considered
the risk of flooding. Other unforeseen circumstances include the installation
of a highway, gas line, oil well sites, etc. on the rented land, creating
inconvenience and additional operating costs for the tenant. In some instances
it may be considered desirable to renegotiate the terms of the lease or
compensate the tenant for the added costs or reduced income they may incur.
Municipal Zoning - the tenant enters into a farm
lease with the express intention of conducting agricultural operations;
it is important that the landlord provide an assurance to the tenant that
the lands are properly zoned for such use. If the landlord is unwilling
to provide such a warranty, the tenant should get advice from the local
municipal authorities to ensure that the purpose to which the tenant wishes
to put the property is permitted.
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Section 2. Termination and Other
Legal Issues
Termination of the Farm Lease
A farm lease can be terminated in a number of different
situations, including:
- Termination at the end of the specified term in the lease (if a tenant
remains in possession of the property after the termination date without
the consent of the landlord, then the landlord can obtain a court order
to have the tenant removed).
- The surrender of the lease by the tenant; that is, the voluntary "giving
up" of the lease with the consent of the landlord.
-
The merger of the lease where the tenant purchases
the leased property from the landlord. The foreclosure of the lease
in the event the landlord defaults on any mortgage on the lands, and
the mortgagee begins foreclosure proceedings. This only applies if
the lease was entered into after the registration of the mortgage
in the land registry office.
-
The giving of notice by the landlord to the
tenant of the intention to terminate the lease. If the lease does
not expressly state a termination date, then the landlord is required
to give notice in accordance with the Commercial Tenancies Act (Ontario).
Weekly tenants must receive one weeks' notice; monthly tenants receive
one months' notice. [Act, s. 28]. The legislation appears to be silent
on the amount of notice required for a yearly lease so it is critical
the parties set out the appropriate length of notice in the written
lease.
-
The court order of a judge when the landlord or tenant
has commenced an action arising from a dispute and the court orders
the lease terminated. This may arise in circumstances where the tenant
has failed to pay the rent in a timely basis or there has been some
other alleged breach of the terms of the lease.
The tenant has certain rights in the event of termination of the
lease by the actions of the landlord. In legal terms the tenant benefits
from the principle known as "relief from forfeiture". This
means that where a landlord is proceeding to terminate the lease,
whether for non-payment of rent or other cause, the tenant may apply
to the courts to remain in possession of the premises upon such terms
as the courts direct, if the termination of the lease would result
in significant harm to the tenant's enterprise. It is up to the tenant
to make a substantial case for relief from forfeiture in the event
that the tenant has otherwise breached the terms of the lease.
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The Commercial Tenancies Act (Ontario) contains some specific issues
relating to farm leases. Most of these provisions relate to the options
available to a landlord when a tenant fails to pay rent. The Act
permits the landlord to seize the goods of the tenant for the
purpose of selling those goods in payment of the rent due to the landlord.
This is called the remedy of distress.
Section 44 of the Act allows a landlord to seize and secure
goods and to sell them, but cannot remove them until the sale takes
place. This includes livestock and growing crops. The landlord can
seize and harvest standing crops for arrears of rent and place them
in an appropriate facility until they can be sold. In this case, the
tenant is granted the right to know where the crop has been taken.
In the event the tenant then pays the rental arrears, together with
any costs incurred by the landlord in pursuing this remedy, the tenant
is entitled to receive the crops back.
Section 46 of the Act specifically exempts livestock on pasture from
the distress remedy if there are other chattels sufficient to pay
the amount owing.
Note that in the case of an insolvent tenant other creditors might
have priority security agreements that rank prior to the interests
of the landlord.
Registration of the Lease
Ontario has a system of registering interests in land, including
leasehold interests. Under Ontario law, a lease for more than 7 years
must be registered in the land registry office where the land is located.
Leases of less than 7 years may be registered by the registration
of a Notice of Lease advising the public that the terms of the lease
can be made known by contacting either of the parties. The advantage
of registering a lease is that a potential purchaser of the property
is deemed to have been notified of the existence of a lease, whether
or not they conducted a title search.
On balance, it is prudent that all leasehold interests be registered
so that public notice can be provided of the claims of both the landlord
and the tenant. The cost of registering the appropriate documents
in the land registry office is currently $60.
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Farm leases are unique in that the farmland is generally used for
dual purposes. One use is for business activities while the other
for the family residence of the owners. The Family Law Act (Ontario)
provides, among other things, that one spouse cannot create an interest
in land, including a leasehold interest, without the consent of the
other spouse if the interest impacts on the use and enjoyment of the
family residence". As such, if the farm lease is to include the
personal residence located on the farm property, it is important that
both spouses sign the lease and acknowledge their consent to the arrangements.
Assignment and Subletting
The Commercial Tenancies Act states that, unless a lease provides
to the contrary, assignments or subletting to a third party can occur
with the consent of the landlord and that such consent cannot be arbitrarily
withheld by the landlord. This requires the landlord to consent to
any reasonable new party taking over the terms of the lease. Because
of this legislation farm leases often contain a clause that permits
the landlord to arbitrarily not consent to such an assignment.
The Landlord and Tenant Relationship
The relationship of landlord/tenant can sometimes be confused with
the relationship of joint venturer's or partners. Because the legal
obligations of these relationships are very different it is important
to clarify the relationship that is intended in a lease agreement.
This is especially true in the case of a crop share lease where
both parties are contributing to a cropping enterprise. The lease
should clearly identify the parties as having the relationship of
landlord and tenant.
The Tenant Protection Act, 1997 (Ontario) deals primarily with the
use of all residential units in Ontario; however, the provisions of
that legislation specifically exempts living accommodations of farm
employees. This means that the specific rules regarding residences
in the legislation do not apply to farm workers who benefit from the
use of farm residential premises as a term of their employment, whether
or not the residential premises are located on farm property.
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Cropland Lease Comparison
Cash Rental
-
Tenant receives the income from all crop sales but
pays the landlord a fixed dollar amount each year as the rent.
-
A portion of the rent may be paid in advance and
the rest at harvest.
-
The tenant bears all the production risk.
-
The tenant receives all the income from crop sales
but the dollar amount paid to the landlord each year varies with
either the price of grain or yield of grain, or both price and yield.
-
Incorporates features of both the Crop Share and
Cash Rent leases.
-
Amount of risk that is borne by the tenant and landlord
depends on the type of leasing arrangement.
Crop Share
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Landlord's Risk for Leasing Arrangements
Production Risk
Type of Lease
Crop Share Lease
Yes
Flexible Cash Lease
Yes
Cash Lease
Type of Lease
Crop Share Lease
Yes
Flexible Cash Lease
Yes
Cash Lease
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Section 3. Types of Leases
There are 3 types of cropland leases - cash rental, flexible cash
rent and crop share leases. What makes each of these leases different
is how the payment for the land is calculated. Cash rental is fixed.
Flexible cash rental and crop share are based on a division of revenue
from the crop in a pre-determined fashion. The above Cropland
Lease Comparison - compares the different cropland leases. In
addition to cropland leases there are building and pasture leases.
Generally a cash rental arrangement would, over time, return less
to the landlord than a crop share arrangement. This is because the
landlord would not be sharing any of the risk associated with growing
the crop and therefore not reap the returns when prices or production
are higher than normal. These risks can be grouped into two categories,
namely production and marketing risk. The Landlord's
Risk for Leasing Arrangements below outlines these risks and shows
which risks are shared by the landlord under the three types of lease
arrangements.
Establishing a Rental Rate
Most rental rates are established by using local market rates, which
reflect the supply of and demand for rental land in a local area.
Crop share and flexible cash agreements use this market rate as the
basis for establishing the crop shares or flexing provisions in the
agreement. In the case of crop shares a traditional 1/3 - 2/3 or 1/4
-3/4 landlord/tenant split is common.
Despite the fact that most rental agreements are based on the local
market rates a tenant and landlord should take the necessary time
to calculate their costs and potential revenues. This will help them
determine, most importantly, if the arrangement will be profitable.
It is also useful when a good market comparison is not available.
It is important to emphasize that determining a fair cash rental
rate or a crop share depends on the landlord and tenant knowing their
costs. In addition, estimates for labour, depreciation, management
and investment need to be taken into account.
Several approaches can be used to determine an appropriate rental
rate. These methods are summarized in below. For greater detail refer
to the specific Factsheets listed. These calculations give you a place
to begin your negotiations and more importantly, provide a safeguard
against entering into agreements that are unprofitable.
Sources of Cost Information
From the Methods of Calculating a Rental Rate
you can see how important it is to know your costs when negotiating
a rental rate. Your own records are the best source of this information,
however when these are not available it is important to use realistic
estimates. The following sources can be of help:
-
Publication
69, Ontario Farm Management Analysis Report (OFMAP)published
annually by OMAFRA
-
Publication
60, Crop Budgets, updated annually these 12 crop budgets can
provide you with cost estimates.
-
-
Leasing Advantages and Disadvantages
Advantages
Lower Capital Investment
- Capital investment is shared between landlord and tenant.
- Landlord supplies land, buildings, and perhaps some of the operating
expenses.
- Tenant supplies labour, machinery, and usually the major portion
of the operating expenses.
- An operator can reach a larger size of business.
- It is also a means for becoming established in farming. Since leasing
is an alternative to ownership, it is really a means of "financing"
a land base.
Disadvantages
Lack of Security of Tenure
- Short-term leases create uncertainty for the tenant.
- Machinery investment is matched to the land base. The cancellation
of a lease could leave the tenant farmer with machinery over capacity
and a higher cost per acre.
- Short-term leases provide more flexibility for landlords since it
is possible to change tenants quickly or to sell the land. However,
short-term leases can work to the detriment of the landlord since
it may not encourage superior farming practices by the tenant.
Advantages
Increasing Financial Efficiency
- When funds are limited it is often more profitable to spend this
money on seed, fertilizer, chemicals, and machinery.
- Investing scarce funds in land may severely restrict the money available
for operating capital thus lowering the efficiency of the farm business.
Disadvantages
Lack of Efficiency, Conservation and Incentive to Make Improvements
- Short-term leases may discourage production efficiency. For example,
some tenants may not use the optimum amount of fertilizer under a
crop share lease unless the landlord shares in the expense of fertilizer.
- Most soil conservation practices are a long-term investment. Most
tenants with a short-term lease are interested only in practices that
will show results during the term of the lease.
Advantages
Obtaining Farm Experience
- Renting enables the beginning farmer to gain needed experience in
the financial operation of a farm business before he commits himself
to a long-term investment in land.
- Enables operator to learn more about land in an area and gives more
flexible position to change farms or to leave farming.
- Renting may enable a younger farmer to obtain the managerial assistance
of an older experienced landlord.
Disadvantages
Availability of Credit
- Tenant farmer usually has a more difficult time to obtain intermediate
and long term credit than does the owner-operator because:
- the lender may require land as security for the loan
- leased land does not build equity
- the lease is short term.
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Advantages
Sharing Risk
- By renting, both the landlord and the tenant can share in the risks
and profits of farming.
- This is particularly important to a farmer with limited capital.
The extent of the risk sharing depends upon the nature of the lease
agreement.
Disadvantages
Lack of Bargaining Power and Managerial Control
- There may be situations where the landlord has greater bargaining
power even though the tenant is a capable manager.
- The landlord may insist on making most of the management decisions
even though his contributions to the lease may be substantially less
than the tenant's contribution.
- For example, the landlord may insist on certain crops being grown
which are not the most profitable as far as the tenant is concerned.
Advantages
Father-Son Arrangements
- A father-son business arrangement might include a lease agreement
whereby the son rents land from the father or rents land from a third
party and shares the machinery investment with the father.
Disadvantages
People Problems
- As with any business venture involving two or more persons, disputes
and disagreements can arise.
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Advantages
Providing Retirement Income
- A retiring farmer might consider leasing all or a portion of his
land base rather than selling.
- Ownership of land provides a hedge against inflation
- The income from the rent provides a form of "pension"
income to live on during retirement.
- A farmer approaching retirement could gradually phase out of farming
by renting a portion of his land and farming the rest of it.
Disadvantages
Lost Opportunity for Capital Gain
- Land prices have generally increased over time although they do
decline occasionally.
- Land appreciation is an added benefit to the landowner even though
the capital gain is not realized until the property is sold.
Disadvantages
Potential Loss of Tax Deferral or Exemption
- Leasing land can in some cases prevent the use of both the tax-deferred
transfer to children and the use of the $500,000 capital gains exemption.
- An accountant should be consulted.
- See Section 4 - Tax Implications of Leasing
for details
Methods of Calculating a Rental Rate
Method
Current Market Approach
How is it Calculated?
- The going rental rate and conditions in the area establishes the
rent for the land.
- Each party should do their own financial projections to determine
if returns will be adequate to make the leasing worthwhile.
Pros
- Usually method used above all others.
Cons
- Difficult if you can't determine local rates.
- There can be a large variation even within a small geographic area
due to type or condition or competition for land.
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Method
Landlord's Cost Approach
How is it Calculated?
-
Landlords determine how much cash rental is necessary
to give desired rate of return on land investment
-
Can be used as a starting point for landlords.
-
The amount is often higher than going market rate
because landlord's capital gain is not included.
Method
Crop Share Equivalent Approach
How is it Calculated?
- Used to establish a cash rental rate.
- Landlord estimates amount of rent received based on a normal
crop share lease.
- Used as basis for establishing or negotiating cash rent.
Pros
Cons
- Need to know costs involved.
- May be more difficult for the inexperienced.
- Must know the normal crop share arrangement
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Method
Income Approach
How is it Calculated?
-
Income and expenses for given situation are estimated
and net income is calculated.
-
Tenant or landlord set rent based on a return
to labour or investment.
-
Tenants use this approach to determine how much
rent they can afford to pay.
Pros
Cons
-
Income and expenses are estimates, may be hard
for inexperienced landlord or tenant to calculate.
-
May not be appropriate for new crops or land rented
for first time
Method
Contribution Approach
How is it Calculated?
-
Each party shares the income from the land in
the same proportion as they contribute to costs.
-
Tenants should receive a larger share if contribute
more in the way of crop inputs, machinery, labour or accepts a
larger risk.
-
Landlord should receive a larger rent for more
productive and higher valued land.
Pros
-
Recognizes the risk and investment of both landlord
and tenant.
Cons
-
Can be difficult to determine or agree on costs
and value of investment, or the return required on the investment.
Landlord may not be familiar with crop costs.
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Section 4. Tax Implications
of Land Leases
The following information is intended for planning purposes
only. It does not replace professional advice from a tax specialist.
While the purpose of this publication is to explain leasing arrangements,
it would be incomplete if it did not touch on some of the tax issues
the tenant and landlord should know.
Landlords can inadvertently disqualify themselves from being able
to use two major tax provisions. This can happen because Canada Customs
and Revenue Agency (CCRA) does not consider many types of leasing
to be farming. Even a share crop lease, where a portion of the crop
is given to the landowner as payment for the land, does not meet their
definition. As a result some leasing arrangements can cause a landowner
to lose the ability to use the tax provisions outlined below. These
provisions are:
-
the ability to use a tax deferred rollover on
the transfer of land to children (called a rollover)
-
the $500,000 capital gains exemption on their land.
Tax Deferred Rollover to Children
The Income Tax Act allows for the transfer of farmland to
a child on a tax-deferred basis. This is accomplished by using what
is called, in tax language, a "rollover". It allows the
transfer price to be set at any value between zero (a gift) and the
fair market value (FMV) of the land. In the case of a gift the transfer
value would be the adjusted cost base (ACB). Transferring the land
at any price up to the ACB would trigger no capital gain while transferring
at FMV would trigger all the gain. Without the use of the rollover
the land would have to transfer at it's FMV and all the gain would
have to be reported.
In order to qualify for the rollover the property must have been
used principally in the business of farming prior to the transfer
by the taxpayer, their spouse or their children who were actively
and continuously involved. This means that for greater than 50% of
the time the land's use was in farming. The property does not however
have to be used in farming immediately before a transfer takes place
in order to qualify for the rollover.
Landowners who have leased a farm property for a number of years
and who want to use the rollover should monitor the percentage of
time that they have leased their land and what type of leasing arrangement
they are using. For example a landowner who farmed a property for
20 years and then leased the land for 4 years could still qualify
for the rollover. If, however, the leasing period was longer than
the farming period it could disqualify the use of the rollover. The
exception to this is if the person leasing the property is your spouse
or child and they are actively engaged in farming.
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Preserving the $500,000 Capital Gains Exemption
The $500,000 Capital Gains Exemption is available to individuals
on the sale of qualified farm property. An individual who had used
their entire $100,000 personal exemption, which was eliminated in
1994, has $400,000 remaining. (If you used this election see the section
"Have you used your $100,000 Exemption"). The exemption
is also available for partners in a partnership, since taxes are paid
at the individual level. Corporations do not have any capital gains
exemption.
Qualified farm property includes:
-
-
shares in a family farm corporation
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an interest in a family farm partnership
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quota (referred to as eligible capital property)
Qualified farm property must meet the
following definitions:
Property must be used in farming by:
-
-
the spouse, child or parent of the individual
-
or by a family farm partnership or corporation
of the individual, spouse, child or parent and
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for property purchased prior to June 18, 1987
it:
-
must be used in farming at the time of sale or
- have been used in farming for any 5 years during its ownership
for property purchased after June 17, 1987
it:
- must be owned for 24 months prior to the sale and
-
in at least 2 years, the gross farm income must
exceed net income from other sources or
the property was used by a family farm partnership or corporation
in a 2 year period during which time the individual, spouse,
child or parent was actively involved in the farming business.
In all cases the qualifying individuals, whether farming as a sole
proprietorship, a partnership or corporation, must be actively engaged
in management and/or the day to day activities of the business.
What Affect Does Leasing Farmland Have on Your Use
of The $500,000 Capital Gains Exemption?
Leasing farmland is most likely to affect the use of the exemption
on land purchased before June 18, 1987. Land purchased before June
18, 1987 must be farmed for any 5 years or farmed
in the year of sale to be considered qualified farm property
and therefore eligible for the capital gains exemption. If the 5-year
rule has not been met then the property must be farmed immediately
before the sale. Since leasing is not considered to be farming according
to Canada Customs and Revenue Agency (CCRA) a lease in the year of
sale could disqualify you from using the capital gain exemption because
it was not farmed immediately before the sale. Even a share crop lease,
where a portion of the crop is given to the landowner as payment for
the land, does not meet their definition. Hiring custom operators
to do the cropping work in the year before the sale since that is
considered to be farming could solve this problem. Alternately a share
crop lease where the landowner is sharing the cost of inputs may also
meet the CCRA requirements of farming. You should discuss such agreements
with your accountant.
Have You Used Your $100,000 Capital Gain Exemption?
The $100,000 capital gain exemption was part of the $500,000 exemption.
The 1994 budget eliminated the exemption but allowed an election to
increase the adjusted cost base of property by up to $100,000, but
not exceeding the February 1994 value. If you elected to use
the $100,000 exemption to increase the ACB, you are deemed to have
disposed of the property in 1994 and you must meet the post June 1987
rules for qualified farm property on a future sale.
Canada Pension Plan and Registered Retirement Savings
Plan
Rental income cannot be used as a basis for contributions to the
Canada Pension Plan. Farmers who lease their land and have no employment
or self-employment income will be unable to make contributions to
the plan. This will have the effect of reducing their Canada Pension
Plan pension at the time it commences. Although rental income is not
eligible for contributions to the Canada Pension Plan, it is earned
income for the purpose of contributions to a Registered Retirement
Savings Plan. Rather than a cash lease the land a landowner could
farm the property by hiring custom operators or lease the land on
a crop share basis where the inputs are shared. The net income from
these sources is eligible for contributions for both the Canada Pension
Plan and Registered Retirement Savings Plans.
Non-resident Witholding Tax
If the landlord is a non-resident of Canada the tenant is required
to withhold 25% of the rent (cash rental or crop-share) and submit
it to Canada Customs and Revenue Agency (CCRA). When the tenant does
not remit the 25% withholding tax, CCRA will attempt to collect the
tax from the landlord. If the landlord does not pay this tax, the
tenant will be liable for the payment.
When a land owner changes the use of their farm land, buildings or
machinery, such as in renting, the Income Tax Act requires
that the depreciable assets purchased before 1972 (Part XVII) be switched
from the Straight Line Method of capital cost allowance to the Declining
Balance Method which is used for depreciable assets purchased after
1971(Part XI). In most cases this is undesirable since it would mean
that all recaptured capital cost allowance that occurs when the class
is closed out (e.g., sale of all machinery in that class) would be
taxable income. The landlord could choose not to use the property
and still maintain the Part XVII status, however, no deduction could
be claimed in the years when it was not used. Any other use, either
personal or rental, would require a change to Part XI. The landlord
could choose to use his machinery or buildings as part of a custom
farming arrangement and thereby maintain the farming status.
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Goods and Service Tax (GST)
Rent that is paid by way of share of the crop is not subject to the
goods and service tax. The treatment of cash rents for GST purposes
depends on whether the landlord is registered with the Canada Customs
and Revenue Agency (CCRA) to collect and remit the GST. A business
(including a landlord who rents property) will not have to register
if it's taxable and zero-rated sales are under $30,000. A landlord
whose only source of business income is rent and the amount is less
than $30,000 need not register. Payment of GST below
shows the possible resulting scenarios.
Farmland Property Tax Program
The Farmland Property Tax program enables eligible farm properties
to be taxed at 25% of the municipal residential/ farm tax rate. The
farm residence and one acre of land surrounding it are taxed as part
of the residential class.
To be eligible for the reduced rate a property must be part of a
farming business with gross farm income of $7,000 or more and must
have a valid Farm Business Registration number. An application to
the program must be filed. For more information contact AGRICORP toll
free at 1-866-327-3678 or visit the Web site at www.farmbusreg.com.
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Payment of GST
Scenario
Landlord is not a GST registrant.
GST
Not required to charge the tax on the rent.
Result
Landlord is unable to recover GST paid on taxable goods and services
but may claim the full amount (including GST) as allowed for business
expense deductions for income tax purposes.
Scenario
Landlord is a GST registrant.
GST
GST must be charged on cash rentals and landlord must remit the GST
collected.
Result
Tenant is able to claim an Input Tax Credit on the
tax paid.
Leasing land will continue to be an important method of controlling
land without having the capital costs of ownership. Developing clear
leasing arrangements is a benefit to both the landlord and the tenant.
This publication is intended as general information and not as specific
advice concerning individual situations. Although it outlines some
of the legal and tax considerations of leasing arrangements it should
not be considered as either an interpretation or complete coverage
of the Income Tax Act or the various law effecting land rental
arrangements. The Government of Ontario assumes no responsibility
towards persons using it as such. All land rental arrangements should
be discussed with your farm management advisor, accountant, or lawyer
before t hey are signed.
The author would like to acknowledge the assistance of Douglas C. Grant,
Barrister and Solicitor, Fergus Ontario and Ed Mitukiewicz,
For more information:
Toll Free: 1-877-424-1300
Local: (519) 826-4047
E-mail: ag.info.omafra@ontario.ca
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