- Capital gains are calculated by deducting the original purchase price of an item from its current value
- Most farmland, quota, shares in a farming corporation and interest in a farming partnership eligible for LCGE
- LCGE has tremendous tax benefits for farmers, but there are issues like the alternate minimum tax (AMT) that can catch you off guard
- While your LCGE will offset a lot of taxes, 50 % of your capital gains still have to be entered as income on your tax return
Canada Revenue Agency (CRA) allows farmers and fishers to reduce tax exposure on the sale of qualified farmland, quota, qualified fishing property, shares in a farming or fishing corporation and interest in a farming or fishing partnership with a $1-million lifetime capital gains exemption (LCGE). A similar $824,176 exemption is available for the disposition of qualified shares of a small business corporation.
Capital gains are calculated by deducting the original purchase price of an item from its current value. Say, for example, you purchased a parcel of land for $300,000 in 1996. If you sold it today for $1,000,000, you would have a $700,000 capital gain.
“All types of capital gain, whether farmland or capital gains on stocks, are 50% taxable,” says Kelvin Shultz with Wheatland Accounting in Fillmore, Sask. “It has to be reported on your tax return as income, and unless it’s covered by your LCGE, it’s taxed at a rate determined by your tax bracket.”
All types of capital gain, whether farmland or capital gains on stocks, are 50% taxable
The LCGE has undergone significant revision since the Government of Canada first introduced it in 1988. Initially, all capital gains were eligible, but over time the program slowly changed to its present form. That’s important to remember: just because farmers, fishers and small business shareholders can use the LCGE today, is no assurance this will always be the case.
What’s in and what’s out
Most farmland, quota, shares in a farming corporation and interest in a farming partnership are eligible for LCGE, Shultz says. Other capital gains you might have from investments in commercial real estate, stocks and mutual funds aren’t.
“The LCGE does have some rules that have to be kept in mind,” Shultz says. “The basic rule for farmland is that you have to have owned it and actively farmed it for two years during which your gross farming income exceeds all other sources of income. After the land has qualified for the LCGE, it can be rented out without affecting its eligibility. However, farmland that was purchased as a real estate investment and immediately rented out would not qualify.”
Shares in farming corporations are more complex, Shultz says. For example, holding excess cash in the corporation, more than you would need for your annual operating expenses, could throw you offside. Likewise, if more than 10 % of the corporation’s assets are inactive, such as cash or farmland being rented out, it’s a problem.
The LCGE has tremendous tax benefits for farmers, but there are issues like the alternate minimum tax (AMT) that can catch you off guard, Shultz says.
“AMT is a tax calculation that runs in the background all the time, but you never see it until you use a large amount of some tax benefits, such as RRSP deductions or the LCGE. When this occurs, your minimum tax can exceed your regular tax and you are forced to pay the minimum. This can be significant; in some cases I have seen minimum taxes in the neighbourhood of $60,000 or $70,000. You have to pay the AMT up front, but it’s refundable over the next seven years and comes off your tax bill when you owe taxes. So it’s not an issue in the long run, but it can create a cash flow issue.”
While your LCGE will offset a lot of taxes, 50 % of your capital gains still have to be entered as income on your tax return. This can be significant. For example, a senior receiving Old Age Security would find the capital gain triggers a claw back if it raises their income above $72,809 (in 2015).
It would have the biggest impact on seniors receiving the Old Age Security supplement or people receiving the child tax benefit. It would also eliminate the GST benefit for low-income earners.
Multiple title owners
Just because two people are registered owners of a parcel of land doesn’t mean they can both claim LCGE benefits. If a spouse isn’t involved in the farm and has never taken income from it, it’s very difficult to argue they should get half the capital gain.
“Technically, whether both a husband and wife, for example, could claim LCGE would depend on who the beneficial owner of the farmland has been,” Shultz says. “If they operated their farm as a true partnership, and both benefited from income from the land, then both would be eligible to claim LCGE on it when it was sold.
But if the husband historically claimed all the income off of the land, it could be a different story. If the wife’s name is only on the title to avoid probate fees when it passes from the husband’s estate to the wife, then she would likely not get the deduction.
“It’s a grey area. Sometimes, if you look a little deeper, you can find factors that can sway a decision.” And good advice is important, because tax rules continually evolve.
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