Should you transfer some of your farmland to your corporation?
The $1,000,000 capital gains exemption can be used to extract tax free cash from your farm corporation
Sean Rheubottom, B.A., LL.B., TEP
It’s possible to transfer some land to your corporation and trigger capital gains sheltered by your available farm capital gains exemption. The corporation pays you in part with a promissory note. That promissory note is a shareholder loan which can be repaid to you tax-free. As the corporation earns farming income, it can pay the after-tax cash to you tax-free as a payment against your shareholder loan. This is a way to extract cash tax-free from your farm corporation. But is it always the right thing to do?
Each individual is entitled to realize tax-free over the course of his or her lifetime up to $1,000,000 in capital gains from the disposition of qualified farm property. This capital gains exemption (“CGE”) can be used either on a sale of land, or at death when the land is deemed sold for fair market value proceeds. The CGE may also be used in combination with the farm rollover to a child either during life or at death.
However, if a corporation owns farmland and later sells it at a gain, the corporation doesn’t get to use the CGE. Only an individual can use the CGE. Therefore many farmers choose to own a significant portion of their land personally rather than corporately.
If you don’t intend ever to sell any of your land for cash proceeds during life, you may feel that you’re losing the opportunity to turn your $1,000,000 CGE into readily available tax-free cash.
A possible idea, which may or may not be right for you depending on the circumstances, is to transfer some land to your corporation, “crystallizing” capital gains to use your CGE. It’s possible to transfer some land to the corporation, receiving shares in exchange, but also receiving a promissory note (creating a shareholder loan account) from the corporation to the extent of the original cost base of the land plus any CGE-sheltered capital gains you trigger using certain tax elections. When the corporation later realizes farming income or income from a final sale of inventory on retirement, or recapture income on a sale of equipment, the sale proceeds, after the corporation’s tax at the low “small business” rate (currently 9%), could be paid to you tax-free to the extent that it repays your shareholder loan.
However, this isn’t appropriate in every case because of several potential issues including:
trapping future appreciation in land value inside the corporation, which on a future sale will not qualify for the CGE;
interference with succession planning such as a desire to pass land to your child personally to allow future use of the CGE;
adverse tax consequences if the land is ever to be transferred out of the corporation to shareholders;
complexity in transferring land to children when it is owned corporately (they may prefer to receive parcels of land directly rather than together receiving shares of a corporation); and
difficulty in convincing a future purchaser to buy shares of your corporation (so you can use the CGE) rather than purchasing the land directly out of the corporation (however, this does work in some cases).
So, should you do the transfer or not? The answer is “it depends.”
Still, setting up that tax-free shareholder loan can work well in certain circumstances. As noted above, it depends. Be sure to get advice from an experienced farm tax advisor before undertaking any such transaction.
Especially if you’re not yet incorporated, there may be better tax planning ideas to look at before this one. We’ll cover those ideas in a future article.
© 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.