Capital gains exemption not keeping pace with land values and costs

Farming is such a high stakes, high capital cost business at the best of times, so any tax relief, particularly as one generation is transitioning ownership to the next, can literally help keep family farms in business, say agricultural tax accountants. 

Sure it has been great to see farmland values increase, at times quite dramatically over the past 30 years or so, say Rob Strilchuk and Ron Friesen, agricultural tax accountants with MNP based in Alberta and Saskatchewan, respectively, but when it comes time for parents to retire and transition ownership to the next generation any tax relief or exemptions that can be applied will greatly benefit both the outgoing and incoming farm operators.

While any individual in Canada with a bonafide farming operation is eligible to claim a $1 million capital gains exemption (CGE) at time of sale, Strilchuk says he would like to see the value of the exemption indexed so it increases annually to at least keep pace with the cost of farming. The $850,000 capital gains exemption available to qualified small business corporations is indexed. It appears unfair that the capital gains exemption available to farm businesses is not.  

When the farm CGE was increased to $1 million in 2015, it was a welcomed tax break, however the fact is that even with that increase it just hasn't kept pace with the ever increasing capital and operating costs facing farmer operators today.

"Agriculture is just such a highly capitalized industry," says Strilchuk, based in Edmonton, who has 30 years experience as a tax and agricultural business advisor. He is also owner and partner in a central Alberta grain farm. "The CGE certainly helps, but not in comparison with some of the dramatic increases we've seen in farmland prices, and the ever increasing farm operating costs over the past three decades."

The implications on transition planning

While there are different mechanisms that can be used to transfer farm ownership, Strilchuk describes a scenario of parents planning to retire, they have a child who will carry on farming, but the parents need money for their retirement - to buy a house in town, and also set up a retirement fund.

"A million dollars sounds good, but is it enough," says Strilchuk. "It varies widely depending on the community, but if you look at the price of real estate today, a million dollars doesn't go that far. So maybe dad and mom are going to need $1.5,  $2 or perhaps $4 million, partially to fund their retirement, and partially to equalize their estate transfer to the non-farming children."

Strilchuk adds a lot will depend on the parents' age and retirement lifestyle, but if we attach a layer of tax to this transaction for an amount that may exceed the current CGE, it just means that mom and dad have to sell (rather than rollover without receiving money) more to the child.  The tax for the amount not covered by the exemption could erode the equity in the farm operation (i.e. mom and dad have to sell more to pay their taxes owing to Canada Revenue Agency) and in turn the farming child has to borrow or finance more to pay mom and dad.  

"So the $1 million CGE only goes so far, and the child who is farming is taking on more debt and they might find themself in a situation where it is more debt than they can handle and maybe they have to sell out completely."

A look at the stats

In an FCC report, farmland value itself has increased an average of seven to eight per cent each year over the past 30 years. That was the average, although in some recent years it increased as much as 30 percent a year.

Statistics Canada also publishes a report that shows the change in farmland and building values on a per acre basis. Across Canada, farmland and buildings were valued at $517 per acre in 1985 with that increasing to $3,266 per acre by 2019. That's an increase of 531 percent, on a national basis with similar increases across Western Canada.

And industry organizations such as the Association of Equipment Manufacturers (AEM)in a recently published reports notes in just the past five years some key pieces of farm machinery have increased anywhere from 30 to 50 percent.

And on top of all this, Ron Friesen, MNP agricultural tax accountant in Saskatoon points out that the buying power of a dollar has decreased over the years as well. An item that cost $20 in 1985 would require about $44 in 2020.

"The current CGE is a significant number," says Friesen, who has 30 years of accounting background. "But what makes agriculture different is that the value of land and machinery over the past 35 years has outpaced the doubling of the exemption over the same time period."

The threat on family farms and community

As we look at farming today if the exemption wasn't there it would almost be impossible for intergenerational transfers to take place, to be affordable, he explains.

"As the farming child needs to find cash for their parents, and / or if there is also a non-farming sibling that needs to be compensated, the debt load can be significant. And the outcome might be that the farm must be sold perhaps to a larger farm which then starts to affect the local community. And maybe it is a reach but you could also take it a step further and if we are seeing family farming operations disappear what impact might that have on food security."

Although Friesen adds that might be on the extreme end of things, he does believe it is important to keep family farms operating, so we have strong rural communities, and one part of that is reducing debt through meaningful tax exemptions.

Strilchuk says anyone who might view the million dollar tax exemption for farm business as a bit generous, may not be considering farmers have had to carry the investment in their farm land for years without any tax support. 

"If we're talking about a manufacturer who has a factory and equipment they would be able to claim depreciation over the years," he says. "A farmer has money invested in his land he is not able to claim any depreciation. So perhaps the $1 million CGE helps to cover those years when the farmer had no tax incentive."

Rob Strilchuk, CPA, CMA, TEP, is a Tax and Agriculture Business Advisor and the leader of the Edmonton region Agriculture Services group. For more information, contact Rob at [email protected] or 780.429.5875.

Ron Friesen, CPA, CA, is a Tax Partner in MNP's Saskatoon office. For more information, contact Ron at [email protected] or 306.664.8324.