Capital Gains Deduction: Tax Solution or Tax Problem?

One of the most important tax benefits available to retiring farmers is the ability to avoid tax on up to $1,000,000 of capital gains arising on the sale of certain farm properties.  Because this is a generous tax exemption, there are complicated rules in the Income Tax Act which are intended to ensure the benefit is available only to qualified persons who meet all of the requirements.  It is important to note the exemption is available only in respect of capital gains.  Therefore, income arising from the sale of livestock is not eligible; nor is recaptured depreciation on buildings, equipment and quota.

Take Bill and Wilma as an example.  Bill purchased his farm land many years ago at a nominal cost.  The entire $1,000,000 capital gain would be subject to the capital gains exemption eliminating the income tax most are familiar with.  However, Bill is still subject to what is referred to as the “Alternative Minimum Tax” (AMT) – which is the government’s response to political pressure from taxpayers upset about certain individuals receiving substantial income without paying a “fair tax.”

If Bill were to decide to sell his farmland for $1,000,000, then he must calculate his tax under the regular method as well as under this alternative method and pay whichever tax is higher. Currently, if the adjusted taxable income calculated under AMT exceeds the basic exemption of $40,000, you will be subject to minimum tax. Bill would not be subject to regular tax but would be caught with a minimum tax of approximately $61,100. In addition, Bill would also have to repay his Old Age Security pension in the year of sale as this is an income-tested program whose benefits are subject to a clawback if your net income exceeds $73,756 (2016).

This $61,100 is recoverable against Bill’s regular tax liability in the subsequent seven years if certain conditions are met.  Any of this AMT that is not recovered during the seven years (subsequent to the year of sale or before death), is no longer recoverable.

What should Bill and Wilma do to minimize the impact of this Alternative Minimum Tax?

  • Establish a plan to ensure sufficient income over the seven years subsequent to the year of land sale to ensure the refundable tax is recovered. Withdrawing sufficient funds from Bill’s RRIF would accomplish this objective.
  • Sell the farm land to unrelated parties over a number of years to avoid the AMT.
  • Sell the farm land from Bill to his spouse, Wilma, over sufficient years to avoid the AMT electing out of the “rollover” rule that normally applies.
  • Sell the farm land to the corporation Bill set up through which cattle, grain and equipment is disposed over sufficient years to avoid the AMT.

Donavon K. Tofin CPA, CA, CFP
The Retiring Farmer Wealth Management Process & Assante Financial Management Ltd.

*Don Tofin is a Senior Financial Advisor with Assante Financial Management Ltd. Please contact him and his team at The Retiring Farmer™ to discuss your particular circumstances prior to acting on the information above.

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