Gifting vs. Selling Farmland or Farm Shares.
If you are thinking of transferring your farmland or shares of the family farming corporation to a relative, you need to consider whether to gift or to sell them. Both farmland and shares of a family farm corporation are two from of qualified farm property (QFP) and are eligible for different transfer rules if certain conditions are met. Careful planning should be taken to ensure that the tax liability from the ensuing capital gains is handled in a manner that best suits the tax situation of both the seller/gifter and the buyer/recipient.
Capital gains would be the difference between the proceeds received and the adjusted cost base (ACB) of the asset being sold. Typically, the ACB of farmland is the original cost of the land when purchased. Half of this capital gain is the taxable portion of the sale which must be reported on your income tax return as income.
The benefit of gifting is essentially deferring the tax liability that results from the sale of the property. If there is to be continued farming operations, it may not make sense to induce a sale of the land transaction if it is not required. Farming operations may not stop within the owner’s lifetime and may not even for many generations. The gifting of land is not considered a sale as no money is received. You are not technically selling it for zero dollars neither, as this would cause the recipient to have the land at an ACB of $0.00; not an ideal ACB when it is time for them to sell or dispose of the land as they would have a large capital gain to deal with.
When you gift farmland to a relative, how it is treated depends on who the relative is. A gift to a spouse or common-law partner is transferred at its current ACB. However, if the land is sold during the transferors’ lifetime, the capital gains on the sale will be attributed back to the transferor’s personal tax return, not the spouse/common-law who received it.
A gift to a child can be transferred at any value between the ACB and the land’s Fair Market Value (FMV). Gifting at ACB would not trigger any capital gains as there is no change in value. A transfer at any value other than its ACB would expose the gifter to a capital gain, which would be the difference between the transfer price and the ACB. The child would then receive the land at the ACB at whatever price it was transferred at. When land is gifted, it is with the assumption that farming operations will continue. If for some reason the recipient decides to sell the land within three years of receiving the gift, the resulting capital gain will be attributed back to the original gifter’s income tax return. In order to put the child’s future capital gain from a possible land sale in the best possible situation, it might be best to transfer the land at a value in which the capital gain could be offset by the highest capital gain exemption amount possible. This way, the child would have the land at the lowest possible ACB without the transferor having to pay any extra taxes in the present has been able to use up any existing capital gain exemption space available.
The lifetime capital gain exemption (CGE) is an amount that every individual possesses that can be applied against certain capital gains resulting from the sale or transfer of any QFP. The amount available to be used over an individual’s lifetime is $1,000,000. The lifetime CGE does not have to be used up in one year but can be used in multiple years. However, once this cumulative amount is used up, it is no longer available. How the CGE works is that if you sell farmland for $4,000,000 which had an original cost of $1,000,000, the capital gain would be $3,000,000 with a taxable portion of $1,500,000. Now, if you applied the lifetime CGE to the capital gain, it would reduce the $3,000,000 capital gain to $2,000,000. This would result in a reduced taxable capital gain portion of $1,000,000. Note that this would only apply if the seller had not claimed any of the lifetime CGE in previous years. If this was the case, the $3,000,000 capital gain less the remaining lifetime CGE balance would be the resulting capital gain.
So how would using the lifetime CGE benefit the child when gifting their farmland? First, let us reiterate that the purpose of gifting farmland is to defer any taxes payable resulting from the sale of the land. Also, let’s recall that you can transfer to a child any value of the farmland between the ACB and the FMV. Using the farmland values from a prior example, if the farmland has an ACB of $1,000,000 and you have not used any of your lifetime CGE’s, you can elect to transfer the land to your child at a $2,000,000 value. In doing so, the resulting capital gain would be $1,000,000, which would be reduced to zero by applying your capital gain exemption to it. This would result in your child receiving the land with an ACB of $2,000,000. Should your child sell this land after three years, the resulting capital gain would be the amount sold less the ACB of $2,000,000 and not the $1,000,000 pre-transfer ACB. This results in a lower capital gain and a lower taxable capital gain needing to be reported. There is also the possibility that the child can also use their lifetime CGE to further reduce the capital gain by $1,000,000.
When you gift land, please remember that you are actually giving the land to a relative. As a result, you will not receive any compensation for the land. Gifting land should be considered if you have an adequate retirement financial plan in place. Of course, for most farmers, their biggest asset is the farmland they possess and plan on using its sale proceeds to contribute to their retirement fund.
Planning for the disposition of farmland or shares of a family farm corporation is a complex issue and should not be engaged without first consulting with your tax professional that is familiar with the rules surrounding QFP. At Talbot & Associates, we have a dedicated Ag Team of individuals that are part of our Ag Team that would be able to help. Don’t hesitate to contact us.