Family farm succession

Estate and tax tips to help keep the family farm in the family

Every business has its own distinct features, but farming really is in a field of its own. The intimate connection between economic activity and family dynamics feeds into farming operations, and in turn into farm succession.

This complexity presents both challenges and opportunities for farmers looking to transfer the farm in an effective and efficient manner. Fortunately, with astute estate planning and strategic application of targeted tax rules, a family farm can indeed be successfully passed down generations.

What’s so special about farm succession?

Nature of the business

Farming is both capital and land intensive, together reinforcing the need for a long-term view and a long-term commitment. Arguably, it’s the prototypical asset-rich/cash-poor business. But, adopting a positive planning perspective, it may be more helpful to think of it as a call to farmers to be vigilantly cash-conscious.

Like other businesses, the farm is usually both the main income source and the main store of a farmer’s wealth. It’s the classic goose and golden egg, with the added element that the farm is also traditionally the family home.

Three-legged succession planning

This intertwined nature may have a farmer feeling paralyzed at the prospect of having to combine everything into a cohesive succession plan. To make it manageable, it may help to approach it as three legs of a succession stool:

1. Farmer’s retirement plan

- Will the farmer/couple continue to live on the farm in retirement, or is another living arrangement intended?
- What kind of retirement lifestyle do they envision, and how much income is needed to fund that?
- What non-farming savings will provide that income, and will it need to be supplemented by farm income?
- If there is a projected shortfall, will retirement be adjusted or might some farm assets have to be sold?

1. Farm management plan

- Have the successor(s) been identified, have they committed, and is there a clear transition timeline?
- Are there gaps in the successors’ farming or management skills, and how long will those take to upgrade?
- Are there any critical employees, and how has their continuing involvement been assured?
- Has the business been analyzed and documented to make it as turnkey as possible for the successors?

1. Family heir/ownership plan

- Will ownership transfer be by sale, by gift, by bequest out of a parent’s Will, or a combination of these?
- Will the successors own the farm outright, or will non-farming family members also have an interest?
- If so, how and when will they get their part of income or assets, and what legal changes might facilitate that?
- If not, will the estate be equalized/‘equitized’ with other property, or will life insurance be used as a stand-in?

For each planning leg, the questions are openers to help organize thoughts and couch expectations of what lies ahead. As in any planning exercise, initial intentions will have to be balanced with practical constraints, possibly leading to difficult trade-offs among farmer, farm and family.

The goal is to make sure each leg is stable on its own, and that together they comfortably support the succession that rests upon them.

Estate planning foundation

Choosing heirs is obviously a key decision, but estate planning is much more than that. Ideally, it comes out of a focused review of a person/couple’s own needs, available resources and wishes for others, followed by legal steps to carry out the plan.

For many people’s estate planning, it can be sufficient to execute powers of attorney (or equivalent legal document for the province) to name someone to make decisions in the case of incapacity, and a Will to deal with property at death, possibly including some brief trust provisions to allow for unexpected contingencies.

For farmers, these core documents will likely need more detailed drafting, possibly accompanied by one or more trusts or corporations. In addition, intended successors may be asked/required to revise and coordinate their own estate planning, including executing domestic contracts to protect against potential marital claims if there is a future relationship breakdown.

This is particularly important with family farms, where financial viability can hinge on keeping the whole intact, and sustaining the scale and momentum of the enterprise.

Targeted tax rules allow flexibility in farm transfers

Alongside economic and interpersonal issues, a major concern in family farm succession is the spectre of tax. When capital property is transferred, tax is generally levied on the capital gain. Ironically, that could cause a profitable farm to be the victim of its own success. Having committed substantial time, effort and resources into the business, a farmer may have only one place to get the cash to pay the tax on its transfer – the farm itself!

Happily, there are a number of rules in our tax system designed to help farmers defer, distribute or eliminate the tax that would otherwise apply on farm property transfers. The key provisions are summarized below, understanding that the qualifying criteria are complex, both for the property and the people involved. Consider this to be a
high-level overview of options and issues to be explored in-depth with the farmer’s own tax professionals.

Lifetime capital gains exemption

The lifetime capital gains exemption (LCGE) can eliminate tax on capital gains when transferring qualified farm or fishing property, or small business corporation shares. The 2024 Federal Budget increased the LCGE from $1,016,836 to $1,250,000 for dispositions after June 24, 2024, with indexing to resume in 2026.

Planning points

- The LCGE can be claimed by individuals, or by partners when gains are allocated from a partnership. A corporation can’t claim it, but shares of the corporation may qualify. (See “qualifying farm property” below.)
- The principal residence exemption (PRE) is available in addition to the LCGE. There are two methods for calculating the PRE when a home is situated on a farm, and the farmer may choose the method that is most advantageous. The PRE may be claimed by individuals and possibly by a partner of a partnership that owns a subject property, but not by a corporation.
- A large capital gain in one year (even if claimed/reduced using the LCGE) can affect eligibility for income-tested benefits in the following year, including Old Age Security, Guaranteed Income Supplement, Canada Child Benefit, G/HST refundable tax credit, age credit and possibly some provincial tax credits.
- Alternative minimum tax (AMT) is often triggered when LCGE is elected, as it brings the non-taxed portion of capital gains into income. AMT is recovered as a credit against taxes payable for up to seven years. Significant changes were passed into law in 2024, which may make it more or less of a concern in a given situation, as advised by tax counsel.
- A parent realizes a capital gain when selling shares to a child, but historically this has been deemed to be a dividend (at higher tax) when selling to a child’s corporation. Bill C-208 was passed in 2021 to allow capital gains treatment in such family transfer situations. Implementation was delayed until further amendments were passed in 2024, designed to prevent surplus stripping and assure that the rules only apply to genuine intergenerational business transfers.

Qualifying farm property

For the LCGE, qualifying farm property includes land and buildings, shares in a family farm corporation, an interest in a family farm partnership, as well as quota and other intangible assets used in the farm business.

The property must be principally used in farming by the individual, a spouse or common-law partner (CLP), child or parent, or by a farm corporation or partnership belonging to one of them. If the property was purchased before June 18, 1987, this requirement can be met if it is being farmed on the date of sale or had been farmed any five years while owned. The use rules are more stringent if purchased after this date, including having to show that gross farm revenue was more than all other income sources over a two-year period during ownership.

Planning points

- Equipment, machinery and inventory are NOT eligible for the LCGE if they are personally owned. However, if those assets are held within a family farm corporation or partnership, their value will contribute to the value of the respective corporate shares or partnership interest, which in turn may be eligible for the LCGE.
- According to the Canada Revenue Agency (CRA), land may not qualify as farm property if it is leased or is under a sharecropping arrangement. Consult a tax advisor to determine how to meet CRA’s requirements.
- When the $100,000 personal capital gains exemption was eliminated in 1994, individuals were allowed to increase the adjusted cost base (ACB) on their property by up to $100,000 that year. Even if farm property was owned prior to 1987, the owner would be deemed to have disposed and reacquired the property in 1994.

Tax-free rollover to a child

When farming or fishing property is transferred to a child, the parent may choose a disposition value between cost (ACB for capital property, or undepreciated capital cost for depreciable property) and current fair market value. This can postpone the tax until the child sells the property. The child must be resident in Canada, and the property must have been actively engaged in farming or fishing activity on a regular and ongoing basis before the transfer.

The transferee may be a natural or adopted child, grandchild or great-grandchild of the individual or of a spouse/CLP, or a spouse/CLP of that person. It may also be someone who, while under the age of 19, had been financially dependent and under the custody and control of the transferor.

Planning points

- If a parent dies before a transfer has occurred, the rollover may also apply on transfer from a parent’s estate.
- If a child dies before a parent, the rollover will not be available to the deceased child’s spouse/CLP.
- If a rollover to a child has been made and the child later dies, the property may be rolled back to the parent.
- If a child sells to a third party within three years of the transfer from the parent, that original transfer will be deemed to have occurred at fair market value for the transferor parent, effectively undoing the rollover to the child.
- Though it is possible to use this rule to transfer to minor children, if the property is sold to a third party while the child is still a minor, the resulting capital gain will be deemed to be the parent’s.
- An estate freeze is a technique used to shift tax on future capital gains to later generations. These rollover rules make it unnecessary to do an estate freeze for tax rollover purposes, but a freeze may still be used to provide ownership certainty to the next generation, and to provide comfort of continuity to the parent farmer.
- The rollover can be used vertically between generations, but not laterally between siblings. Farmers should take this into consideration when deciding when and how to structure a succession among multiple children.

Tax-free rollover to spouse

Any capital property (not just farm property) may be transferred by rollover to a spouse/CLP, but any income or capital gains arising out of that property will be attributed to the transferor under the spousal attribution rules.

Alternatively, if it is a purchase at fair market value, the spouse/CLP will be taxed on the year-to-year income and realized capital gains, achieving some family income splitting. Even better, when that property is later sold, this ensures that the capital gain is realized by that spouse/CLP who can then use his/her LCGE.

Extending the capital gains reserve from 5 years generally, to 10 years for farm property

Generally, a capital gain is recognized and taxed in the year of disposition. If payment is deferred, the taxpayer may elect to recognize the gain across as many as five years, being the year of closing plus four years.

For disposition of a family farm, a fishing property or small business corporation shares to a child (using the same extended definition of child outlined above), the reserve period may be as long as nine years following the year of disposition, spreading the tax liability across as many as ten years.

Coordinating professional advice

Business succession planning can be a challenge, with farm succession being a breed unto itself. Add in family dynamics, and things can get especially complicated.

While there are many tax rules designed to facilitate family farm succession, they are most effective when applied in the context of each particular farmer, farm and family. Through early engagement of qualified legal and tax advisors – and with the commitment and participation of all affected family members – a farmer can be confident that the family farm succession will indeed be a success.

In a field of their own: Targeted tax treatment for farmers and fishers

While each of us is unique in any number of ways, as taxpayers, we have much more in common than that which distinguishes us. Even so, those earning a living from the land or sea face very different challenges than do other occupations.

The distinctive nature of farming and fishing is acknowledged through a variety of targeted tax rules. These range from assisting farmers and fishers in their year-to-year operations through to facilitating continuity of their operations down generations. Here are the key measures.

How and when to report income

The fiscal period for reporting income is usually 12 months. For employees and self-employed individuals, the general tax rule is that the fiscal period is the calendar year, though a farmer or fisher may apply to have a non-calendar year-end.

Farmers and fishers are also entitled to choose between accrual or cash accounting. Under accrual accounting (the general rule), income is reported when earned and expenses when incurred. Comparatively, cash accounting reports when amounts are respectively received or paid. Farmers and fishers may move from accrual to cash accounting simply by filing their next tax return in the new manner. However, permission to return to the accrual basis is required from the local tax-services office.

Farming losses

If someone has a farming or fishing loss in a year, it may be carried back up to three years or carried forward up to 20 years. As such farm losses may be taken against any other income, this has been an area of much contention between so-called hobby farmers and the Canada Revenue Agency (CRA) over the years.

Just because someone lives on a farm does not make that person a farmer. If the farm was not run as a business, the person cannot deduct any farm-related losses. Where the farm activity was run as a business but was not a main income source, part of the loss may be deductible under the “restricted farm loss” formula. The details are beyond the scope of this article, but the topic is covered in CRA Guide T4003, Farming Income.

Succession and capital gains

Farming and fishing are capital-intensive businesses, many being at the heart of communities dependent upon their continuity. Absent there being laws to recognize this condition, those operations, their expertise and the communities themselves may be at risk. Capital gains rules have been modified in a number of ways to accommodate.

Lifetime capital gains exemption (LCGE)

Likely the most commonly known capital rule for farmers and fishers is the LCGE on qualified farm or fishing property (QFFP). Its value was raised from $813,600 to $1 million in 2015. It is shared with the LCGE on small business shares (i.e., the maximum is $1 million in total). The latter continues to be annually indexed from that 2015 value, and once it exceeds $1 million, the two will index in lockstep once again.

QFFP covers capital property used and owned by the taxpayer, spouse or common-law partner, including

real property, such as land and buildings;
shares of the capital stock of a family-farm or fishing corporation;
interest in a family-farm or fishing partnership; or
eligible capital property, such as milk and egg quotas.

Transfer to a child

When farming or fishing property is transferred to a child, the transferor may postpone tax on any taxable capital gain and any recapture of capital cost allowance until the child sells the property. To qualify, the child must be resident in Canada, and the property itself must be in Canada and have been actively engaged in farming or fishing activity on a regular and ongoing basis before the transfer.

The transferee may be one’s child or that of a spouse or common-law partner, and further includes

a natural or adopted child;
a grandchild or great-grandchild;
a child’s spouse or common-law partner; or
another person who is wholly dependent on the transferor for support and who is, or was immediately before the age of 19, in that person’s custody and control.

Extended reserve claim

The general rule for recognizing capital gains is that they are recognized in the year of disposition. If payment is deferred, the taxpayer may elect to recognize the gain across as many as five years, being the year of closing plus four years.

For disposition of a family farm, a fishing property or small business corporation shares to a child (using the same extended definition outlined above for transfers), the reserve period may be as long as 10 years.

CRA guides

Beginning in 2017, CRA Guide T4004, Fishing Income, will no longer be published. It will be replaced by Guide T4003, Farming and Fishing Income. The T4003 will include tax information for both farmers and fishers. [Postnote – As of 2018, guide T4003, Fishing and Farming Income, is no longer published. Instead, use guide T4002, Self-employed Business, Professional, Commission, Farming, and Fishing Income.]

Restricted farm losses – Chief income source rule reinstated

At issue

Like any other endeavour, farming can sometimes be a profitable undertaking, and at other times a losing proposition. Should losses arise in a year, the ability to deduct them depends on whether there had been an intention to undertake a commercial activity, and what other income sources the taxpayer may have had:

Where a farming business is the chief source of income, losses can be applied against other income sources, including 3 year carryback and 20 year carryforward.
At the other extreme where there is no expectation of profit – so-called ‘hobby farming’ – losses are not deductible, despite that any net income is fully taxable.
In between, where the “chief source of income … is neither farming nor a combination of farming and some source of income” [Income Tax Act s.31(1)], the ‘restricted farm loss’ rules apply.

It is this in-between category that is often a bone of contention between taxpayers and the Canada Revenue Agency (CRA). A formula is used to cap the amount of losses that may be claimed in a given year to $8,750. As with the chief income source, these losses may be carried back 3 years and forward 20 years, but can only be used against farming income.

A taxpayer win over the CRA at the Supreme Court of Canada (SCC) in 2012 drew the government’s attention, with a double-edged response making its way into the 2013 Federal Budget.

Moldowan v. The Queen, [1978] 1 S.C.R. 480

This SCC decision sets forth the three classes of farming taxpayers summarized above. On the facts, the Court found that Mr. Moldowan’s farming business was subordinate to his other sources of income, and therefore the farm loss deduction limitations applied.

This case has been considered and followed in dozens of subsequent cases.

Gunn v. Canada, 2006 FCA 281

In the approximate three decades that elapsed since Moldowan, there had been much criticism of the judgment. It required farming to be the chief source of income in both the first and second classifications, despite that nothing in the relevant ITA sections appears to require that.

In the Gunn decision, the Federal Court of Appeal sought to give effect to the word “combination” in the second classification, and declined to follow Moldowan.

Canada v. Craig, 2012 SCC 43

In Craig, both the trial and appeal courts followed the FCA in Gunn, effectively purporting to overrule Moldowan. The SCC in the present case remarked that the lower courts should have merely given reasons why they found Moldowan problematic, but otherwise followed it. Still, the matter now stood before the SCC.

The judges then proceeded to review the troubled history of Moldowan, and the concurrent development in legislative interpretation at the SCC. There is a delicate balance between the values of correctness and certainty when the top court considers overruling one of its own decisions, but in the end that is what it did.

The revised view of “combination” is to look at a variety of factors including capital invested, time spent, farming history and future intentions. If a taxpayer places significant emphasis on both farming and non-farming income, the combination suffices to be the chief source of income whether or not the farming income is greater.

Mr. Craig was entitled to his approximate $425,000+ losses for the two years in question.

Federal Budget – March 21, 2013

The Budget document briefly recaps the preceding history culminating in Craig, then proposes to restore the interpretation in Moldowan. Assuming passage of the Budget, for taxation years ending after March 21, 2013, “a taxpayer’s other sources of income must be subordinate to farming in order for farming losses to be fully deductible against income from those other sources.”

Concurrently, and in recognition that the deduction limits have not changed for 25 years, the formula will be amended to effectively double the annual deduction limit to $17,500.

Practice points

Certainty is an important part of legal and tax planning. Unfortunately for part-time farmers, it is now the certainty of being caught by the restricted farm loss rules where farming is not the chief source of income.
For those taxpayers with more modest farming losses than the six figure amounts in these high-profile cases, the doubling of the deduction limit is the good news in this development.