What if you don’t qualify for the farm rollover to your children? This trust planning trick might help.

A carefully drafted trust in your Will brings the farm rollover back even if you’ve been renting the land out for years

Sean Rheubottom, B.A., LL.B., TEP

If you’ve been renting your farmland to someone outside the family for a number of years, you may have lost the ability to transfer the land to your children on a “farm rollover” basis. However, you may be able to use a “spousal trust” in your Will to make the farm rollover available, no matter how long you’ve been renting the land out.

I recently had an opportunity to help a retired farming couple, John and Barbara, save about $530,000 in future tax under their estate plan. John and Barbara live in B.C. but still have their jointly-owned farmland in Saskatchewan. They’ve been renting out the land for quite a few years but they want to keep it in the family, passing it on to their children through their Wills. They understood that under the tax rules regarding farm rollovers, they will not be able to “roll” their farmland to their children either during life or at death. The rules provide that if farm property has been rented outside the family for too many years, the farm rollover does not apply. Generally, if the land has been rented out for greater than half the years the property has been owned, the rollover is not available.

But in this case there was an estate planning solution that brought the rollover back.

The farm rollover

The tax rules provide that at death, you are deemed to have sold all of your capital property including farmland, for fair market value proceeds. Any resulting capital gains that aren’t sheltered by the capital gains exemption are taxed on your final tax return. The highest tax rate on capital gains in 2021 in Saskatchewan is 23.75%. (In the case discussed here, the clients are resident in B.C. where the capital gains tax rate is higher, at 26.75%.)   

However, the farm tax rules provide that if farmland or equipment was used before death “principally” in the family farming business in which you or family members were actively engaged, then it can pass to your child at death on a “rollover”. Instead of being deemed sold at fair market value, it is deemed to have been sold at cost, resulting in no capital gain and no tax. Your child receives the property with your cost base. There’s an opportunity for your executor make an election on your final tax return to cause this deemed sale to occur at any amount between cost and fair market value. This allows any remaining capital gains exemption or unused capital losses to be used, so your child may benefit from a higher cost base.

The “do nothing” plan

We’ll keep this example simple by disregarding the growth in the value of John and Barbara’s farmland that is sure to occur, making the potential tax (and savings) even more significant.

John and Barbara want to leave their land to each other first , then ultimately to the children when they are both gone. Assume John dies first and Barbara dies some time later. On John’s death, his interest in the jointly owned land would “roll” to Barbara at cost, because the tax rules provide a tax-deferred rollover for assets left to a surviving spouse at death.

On Barbara’s second death, the land will be deemed sold at fair market value. The land has total inherent capital gains (fair market value minus cost base) of around $4,200,000. Because there is no farm rollover and no capital gains exemption remaining, the tax bill at the top B.C. capital gains tax rate of 26.75% would be about $1,100,000. Can we do better than that?

An obscure tax rule that occasionally comes in handy

I dug deep into my memory banks and recalled a very special rule for farmers in the Income Tax Act. This rule has been around for many years and seems designed to help farmers who want to leave their land to benefit their spouse who will not personally farm the land, then ultimately give the land to their children who might actively farm the land.  

The rule provides that that if farm property is left at death to a spousal trust (for example, a trust for Barbara), then upon the beneficiary spouse's (Barbara's) death, the farm property may pass from the spousal trust to a child on a “farm rollover” basis. In this case the requirements regarding who is actively farming the property are more lenient while the property is held in a spousal trust. For example, the property could be leased to someone outside the immediate family while the property is held in the spousal trust, and still qualify for the farm rollover to your child upon the spouse's death. There is no requirement as to who was using the property before your death, as long as it was used in farming. On the transfer to the spouse, the “spousal rollover” applies, and then on the spouse’s death, the “farm rollover” to children applies as described above, including the possible election of deemed sale proceeds between cost and fair market value.

So there it is. A tax rule that allows the farm rollover to apply in circumstances where there was no hope of a rollover. All you need is a spouse who outlives you. And someone who knows how to draft a tax-planned trust.

What about the joint ownership?

John and Barbara own their farmland jointly. Except in very specific situations, when one joint owner dies, the joint property passes directly to the other joint owner by right of survivorship. There is no opportunity for the property to be held in a trust for the survivor because it never forms part of the deceased’s estate.

So I proposed a plan as follows. John and Barbara would each transfer a half-interest in the land to the other, resulting in each of them owning separate, not joint, interests in all the same land. When spouses transfer assets to each other, there is an automatic rollover under the tax rules. Income “attribution rules” would apply going forward, with the result that they will simply continue reporting the rental income the way they always did. On the death of one of them, the separate interest of that spouse in the land could pass, under that spouse’s Will, to a spousal trust for the survivor of them on a “spousal rollover” basis. On the death of the beneficiary spouse, that land could pass to the children on a “farm rollover” basis as described above. The land that remained in the hands of the second to die spouse would be subject to capital gains tax at death, since there would be no farm rollover as the land was never held in a spousal trust.

Long story short: a tax saving of $550,000. The $1,100,000 tax bill on the second death will be reduced by about half, to $550,000.

There is an added cost in the form of probate fees because the land held by the first to die spouse will pass through their estate to be held in the spousal trust. But in Saskatchewan probate fees are only $7 per $1,000 of estate value - in this case a total cost of around $14,700.  So the total tax savings are reduced to about $535,000.

I wanted to make sure I had the blessing of John and Barbara’s accountants so I ran the whole plan past them. They liked it, and we presented it to our clients as a team.

© Heritage Private Wealth Law

General information only; not intended as legal or tax advice. Readers are encouraged to obtain legal and tax advice before acting in their specific circumstances.