The Ten Top Tax Questions on the Capital Gains Exemption
If you asked me what is the most common tax question I get asked it would be a no brainer - capital gains. The $1,000,000 capital gains exemption to be exact. And yes, it is $1,000,000 - it was increased back in 2015. The reason for all the interest is because the exemption is the single largest tax break that farmers get. Although good tax planning may yield even larger benefits over time, the capital gains exemption is seen as the "big one".
Here is my Top Ten list for farm tax questions regarding the capital gains exemption, based on the inquiries I get.
- What type of property qualifies for the exemption?
Land, quota and buildings all qualify. So does an interest in a family farm partnership or shares in a family farm corporation. The technical term is "qualified farm property". Machinery does not qualify, which is OK because machinery does not usually increase in value.
- How much or how long does the property have to be used
in farming to make it "qualified farm property?"
There are two sets of rules depending on when the property was purchased. One is easy to meet the other is harder.
Easy Test: For property purchased on or before June 17, 1987 the property must be used in farming at the time of sale or for any five years during its ownership.
Harder Test: for property purchased after June 17th, 1987 the property has to be owned for 24 months and in at least two years the gross income from farming must exceed net income from all other sources. However, this income test is not applied if the property is used in a family farm partnership or family farm corporation for at least 24 months and the individual, spouse, common-law partner, child or parent was actively and continuously involved in the farming business. This fact can be advantageous for folks who have off farm income and cannot meet the income test.
- Does the person who owns the property have to use it
No. As long as the property was farmed by your spouse, common-law partner, child or parent you can still access the exemption. Many children who inherit land from parents are surprised to learn that although they have never farmed the property, they qualify for the $1,000,000 exemption. In other words if it was qualified farm property for your parent, it is qualified farm property for you and you can use the $1,000,000 capital gain exemption.
- I used my general $100,000 capital gain exemption back
in 1994 when it was eliminated. How does that affect my $1,000,000
It affects it in 2 ways:
*It reduces your exemption, so you now have $900,000 if you used the full $100,000.
*It may mean that you have to qualify under the harder test described earlier.
Let me explain. Up until 1994 everyone had a personal capital gains exemption of $100,000 for general property. The budget that year eliminated this benefit, but allowed individuals to use up the exemption by simply electing to "bump up" the cost base of the asset.
If however, you elected to use the $100,000 exemption on your farm property you were deemed to have disposed of and re-acquired the property in 1994. The result: you must meet the harder post- June 1987 rules for qualified farm property on a future sale. There is no way to reverse that election
- Does the exemption apply to the individual or the property?
The exemption is based on the individual. This means that a parent might use the full exemption on a transfer to a child and then the child has the same $1,000,000 exemption available. Or if there are multiple children then each of them have the full exemption. Spouses each have the exemption if they are on title together.
- Can I just add my spouse's name to the title before
I sell the property and double up the exemption?
If the capital gain in the property is greater than the $1,000,000 exemption then this might seem like a good strategy. Unfortunately, the tax rules prevent you from just gifting the property to your spouse and creating an instant $1,000,000 tax break. What happens is the capital gain is attributed back to you on the sale. The only way to avoid that is to sell the property to the spouse at FMV (fair market value), charge current interest rates on any loans to the spouse and not use the tax deferred rollover provisions that can apply to a transfer to a spouse. The result … your sale to your spouse at FMV will trigger the capital gain you were trying so cleverly to move to your spouse. Instead of an attributed gain you get the actual gain. Those tax policy folks are not stupid!
- Can the exemption be used upon the death of an individual?
Yes, an executor can trigger a capital gain and use the exemption with the final tax return. This increases the cost base of the property which benefits the beneficiaries, whether spouse or children. This should usually be done if the deceased individual has any exemption available.
- Can I sell land to my children and then have them sell
the land to "double or triple up" the capital gain exemption?
Here are two points of discussion on this topic … the assumption is that the sale to your child was below FMV would use up your exemption, and then when your children sell it they would use their exemption. Tread carefully here. If you sell the assets within a three year period or even make arrangements to do so, Canada Revenue Agency will consider this to be tax avoidance and will deem that you sold the property to your children at fair market value, thus triggering all the gain in your hands. Get tax advice on this one for sure. Secondly just in case you had not thought about this, your children really will own the assets, and all the money they get from the second sale.
- Can a corporation access the capital gains exemption?
A corporation does not have any capital gains exemption. You might be able to use up your exemption on the transfer of assets to the corporation, but once the corporation owns it there is no further exemption. If the corporation sells the asset, 50% of the gain is taxable in the corporation and the other 50% goes into the capital dividend account from which tax free dividends can be distributed. Having said that, the shares of a family farm corporation are qualified farm property and the exemption can be used if a share sale takes place.
- Can a partnership access the capital gains exemption?
Partnerships are not taxed as a separate entity. Profits flow out to the partners, which means that a capital gain on the sale of a partnership asset flows out to the partners as a capital gain. If they have access to the capital gains exemption they can use it. The exemption can also be applied to the sale of an interest in a family farm partnership.
For further questions you can please refer to my factsheets on the OMAFRA website at www.ontario.ca/agbusiness and look under the Financial Management section.
For more information:
Toll Free: 1-877-424-1300
|Author:||Erich Weber - Business Finance Specialist/OMAFRA|
|Creation Date:||23 February 2010|
|Last Reviewed:||4 October 2017|