Help your farmer clients maintain their tax advantages, Part 2

Seedlings, close up — © Koji Kitagawa/Amanaimagesrf / Thinkstock

Determining whether a client has a qualified farm or fishing property that’s eligible for the $1-million lifetime capital gains exemption requires extensive analysis.

For an individual taxpayer such as Paul — the owner of an estate winery whom we met in Part 1 — a qualified farm or fishing property (QFFP) includes land, buildings, quotas, a share of capital stock of a family farm or fishing corporation, or an interest in a family farm or fishing partnership.

Whether or not Paul’s vineyard qualifies as farm property depends on when he acquired the property, as well as various ownership and use criteria. Similar criteria also apply where the farm is operated through a family farm partnership or a trust. (A family farm partnership is a farming operation owned and operated by partners who may be spouses or children, or corporations owned by these family members. A trust is a relationship that separates legal and beneficial ownership.)

At the time of disposition, the vineyard must be owned by Paul; his wife, Linda; or a family farm partnership in which Paul and/or Linda own an interest. An interest in a family farm partnership is considered qualified farm property, for purposes of each partner’s lifetime capital gain exemption (more on this below).

If Paul acquired the vineyard after June 17, 1987, these rules must also be met:

The property is subject to a minimum 24-month holding period immediately prior to Paul’s disposition. During this time, the property must be owned by either Paul or an eligible individual. An eligible individual could include Paul, Linda or their parents, grandparents and great-grandparents as well as children, grandchildren and great-grandchildren. A family farm partnership in which either Paul or Linda owns an interest is also considered an eligible individual.
For those two years, the vineyard must have been used principally (defined by the CRA as more than 50%) by an eligible individual actively engaged in farming on a regular and continuous basis.
A gross revenue test must be met. This test requires that for any two-year period of ownership by any eligible individual, the farmer’s gross revenue from farming exceeded all the farmer’s non-farm income for the period. While the farmer must be an eligible individual, the farmer doesn’t have to be the owner.

If Paul acquired the vineyard on or before June 17, 1987, the use criteria are more flexible, with no 24-month holding period or gross revenue test. Either of the following must be met:

In the year Paul disposes of the vineyard, it must be used principally in farming by an eligible individual; OR
For at least five years during ownership by Paul or other eligible individuals, the vineyard must have been used principally in farming by one of the same.

Note that if Paul made a capital gains election on the vineyard prior to February 22, 1994, the vineyard would be deemed last acquired by Paul after June 17, 1987, and subject to the more stringent rules.

In determining whether a vineyard is used principally (more than 50%) in farming, the following interpretations regarding the land have generally been used:

Land use may be considered on a parcel-by-parcel basis.
More than 50% applies both to years farmed compared to years owned and the proportion of property used for farming.
Renting land doesn’t count as farming.
Joint venture arrangements (as opposed to cash rent or sharecropping) are acceptable. A joint venture goes beyond a landlord/tenant arrangement — it’s akin to a partnership formed to achieve a specific result, such as growing grapes in a vineyard or growing grain on a quarter of land, where the farmer remains actively engaged in the activities of farming.
The farmer can hire workers so long as the farmer makes planting, harvesting and other production decisions.

Note also that if Paul and Linda were a non-farm couple who inherited land farmed by Paul’s parents or grandparents, the land could be considered QFFP to both Paul and Linda, assuming an eligible individual met the gross revenue test. When Paul passes away, the land will no longer be considered QFFP to Linda.

The advantage of partnerships/corporations

If Paul owned the vineyard as a family farm partnership or corporation, similar criteria for LCGE qualification apply. For at least 24 months, more than 50% of the fair market value (FMV) of partnership property must have been used principally in farming (by an eligible individual who is actively engaged in farming on a regular and continuous basis). At the time the property is disposed of, at least 90% of the value must be used in farming.

With no gross revenue test, partnerships and corporations have an advantage over individual ownership in qualifying for the LCGE. In the 2014 case Otteson v The Queen (2014 TCC 250), a husband and wife were able to claim the LCGE on the sale of their farmland despite having substantial off-farm revenue because they successfully argued they were operating as a family farm partnership.

Otteson is particularly relevant to the wine industry or others where operations are a mix of farm and non-farm activities. Although Tinhorn (see Part 1) successfully argued access to cash-basis reporting for winemaking, the CRA generally doesn’t consider winemaking to be farming. Mixed operations may even put a vineyard offside LCGE eligibility and other provisions available to farmers.

If Paul and Linda’s family farm partnership grows grapes in the vineyard but has other uses for the land, including residential use, or makes wine from the grapes, owning parcels of land separately may better pave the path for the partnership assets to meet the 50% and 90% use tests required for LCGE eligibility on disposition.

Otteson further supports this to the benefit of estate winery owners, since it’s acceptable for those in the wine industry to carve up single-titled property for tax purposes according to varied uses such as vineyard, principal residence, non-farm winery land and buildings.

As your client aims to structure their business operations in the most tax-efficient manner, they may have to consider the ownership and use rules for LCGE qualification. Clients must consider the blend of business structures, owners and users that make sense for their business, family and taxes.

In the next article, we’ll consider a QFFP rollover to children.

Rebecca Hett, CPA, CGA, TEP, is vice-president, Tax, Retirement and Estate Planning at CI Investments.