If you sell the business in the future or pass it on to your children at death, you can make use of the capital gains exemption.
The capital gains exemption is indexed for inflation for taxation years after 2014. The exemption for 2023 is $971,190. Note that the exemption was increased to $1 million on dispositions of qualified farm or fishing property on or after April 21, 2015. These exemptions are only available to individuals and not corporations.
A note of caution — careful planning is required in order to take advantage of the capital gains exemption. The tax rules that must be complied with are complex. For example, for an asset to qualify for the capital gains exemption, there are significant tests that must be met. It’s also important to get good tax advice if you own property that has been farmed by family members in the past. Even if a family member is not currently farming it, it may still be considered to be qualifying farm property and therefore any gains would be eligible for the capital gains exemption when it is sold. It’s important to work closely with your BDO advisor to ensure that you will benefit from the exemption where appropriate.
Qualifying shares of an SBC
To use the capital gains exemption on the sale of shares of an SBC, you must meet the following conditions:
- The corporation must be an SBC at the time of the sale.
- More than 50% of the corporation's assets (on the basis of fair market value) must have been used in an active business carried on primarily in Canada throughout the 24-month period immediately before the sale.
- The shares must not have been owned by anyone other than you or someone related to you during the 24-month period immediately before the sale.
For more information on the sale of qualifying shares of an SBC, see our tax bulletin Incorporating Your Business
Qualifying farm property
Qualifying farm property includes real property, farm quota, shares in a FFC and an interest in an FFC. It does not include machinery and equipment, livestock, or crops. It is important to note that you do not have to incorporate your farm in order to claim the capital gains exemption as real property, farm quota, and certain other property used for farming can be disposed of through an asset sale and qualify for the capital gains exemption.
Claiming the exemption on farm property when incorporating
Owner-managers of non-farm businesses can only claim the capital gains exemption where the corporation is a small business corporation that meets certain requirements (as outlined above) and they sell the shares. Farm business owners, on the other hand, have a lot more flexibility in claiming the capital gains exemption and unlike the rules that exist for the shares of an SBC, farm owners can convert the capital gains exemption into cash due to the ability to claim the capital gains exemption on property other than shares. This is important as most farm business sales are structured as a sale of business assets and not shares.
The exemption, available only to individuals, basically ensures that you do not pay tax on the first $1 million of capital gains arising from the disposition of qualifying farm property. If a farming property or quota is transferred to a corporation and then it increases in value, a capital gains exemption cannot be claimed if these assets are sold by the corporation. However, if these assets already have an accrued gain, it is possible to use your capital gains exemption by transferring these assets to the corporation to trigger a gain eligible for the capital gains exemption or to transfer the assets to the corporation using a rollover election and electing to receive proceeds equal to an amount large enough to trigger a gain equal to your remaining capital gains exemption. This will create the ability to take cash out of the company on a tax-free basis or take back corporate debt up to the amount of the elected transfer price. The amount of cash that can be withdrawn is equal to the proceeds for capital gains purposes. Therefore, if the corporation later sells the asset, the capital gains exemption has been effectively locked into the corporation’s cost of the asset and you will be able to receive part of the proceeds as repayment of the debt. Or you can pay out after-tax small business income to yourself prior to the sale of the asset in question as a debt repayment.
There are downsides to this type of planning as well — in certain circumstances, it is advisable to maintain ownership of real estate and quota personally, where possible, and only transfer farm inventory and equipment to the corporation. The real estate and quota can then be leased to the company. When the farm is sold and the corporation sells its business assets, the assets held personally can be sold at the same time and the capital gains exemption can be used to exempt the capital gains on the assets that were held personally. Note that many marketing boards have rules regarding incorporation and they may not allow the quota to be kept outside the corporation. However, some will allow the quota to be held outside the corporation if certain conditions are fulfilled.
Claiming the exemption on a share sale
You can also claim the capital gains exemption against the gain from your FFC shares, but it’s important that you structure the sale of your farm as a sale of shares of the company and not as a sale of the farming property that is owned by the company. On the sale of FFC shares, you may be able to claim your capital gains exemption as long as “all or substantially all” of the assets in the corporation were used principally in the farm business. Note that if this test is not met, it may be possible to remove the redundant assets from the corporation prior to a sale to ensure that the shares are qualifying property. As well, throughout any 24 month period ending before the disposition, greater than 50% of the fair market value of the assets of the corporation must have been used principally in the farm business in which a qualified user was active.
Keep in mind, however, that the purchaser of your farm will likely prefer to purchase your farming property directly from the company, rather than purchasing the shares of your family farm corporation. This is due to the fact that the amount that they pay for your shares will be reflected in the tax cost of their shares, which will only be of benefit to them when they dispose of them. However, if they buy the assets directly, the amount they pay will be reflected in the tax cost of the individual assets they have purchased which they may be able to write-off for tax purposes as they run the farming business. Therefore, the purchaser may ask for a price discount if you insist on selling the shares. Keeping quota and real property in your hands personally (where possible) will help minimize this problem.
Note that these difficulties can often be overcome if the main asset of the farm is non-depreciable land. Through careful tax planning, the purchaser can usually purchase shares and then reorganize their affairs to transfer the amount that they paid for the shares to the tax cost of the underlying land held in the corporation.
As noted earlier, each Canadian resident individual is entitled to one lifetime capital gains exemption that can be claimed against capital gains realized on transfers of ownership of qualifying farm property (or qualified small business corporation shares). It makes sense that if you, your spouse and your children realized capital gains on the sale of your farm and each claim the capital gains exemption, your family’s overall tax bill on the sale of your farm can be significantly reduced.
What steps can you take to ensure that all family members can take advantage of their capital gains exemption? This can only be accomplished if you properly plan as you approach retirement. Refer to our bulletin Tax Planning for Canadian Farmers and article Farm transition: Is your farm offside? for examples where it may be possible to maximize your family’s exemption claims by transferring ownership of farming property to your spouse or to your children.
Talk to your BDO advisor before making any decisions to sell your farm business.
Some points about the capital gains exemption
If you plan to realize capital gains on your farming property and claim your lifetime capital gains exemption, there are some additional issues that you need to discuss with your BDO advisor. Even though no income tax has to be paid on a capital gain when the exemption is claimed, there can be other negative consequences. These include:
- Old Age Security (OAS) — A taxable capital gain (even one against which the exemption is claimed) will increase your net income for tax purposes. If you are 65 or older and receiving OAS, the benefits you receive will be reduced when your net income exceeds $81,761 (for 2022). Full OAS benefits will be completely eliminated when net income exceeds approximately $135,000. Similar problems can arise for recipients of guaranteed income supplements.
- Age Credit — Similarly, the age tax credit, available to you when you are 65 or older, is reduced by 15% of your net income in excess of approximately $40,000 (varies by province).
- Alternative Minimum Tax (AMT) — A large capital gain may trigger an AMT liability on your tax return. Furthermore, the 2023 federal budget proposed significant changes to AMT that could result in a higher tax liability when the new rules come into effect in 2024. Although this tax could be refundable in future years when regular income tax exceeds AMT, this can cause you cash flow problems when you have to pay this tax for the year in which the capital gain is triggered. The carryforward period is limited to 7 years, at which point any unused AMT carryforward amount becomes an additional cost, instead of a pre-payment of tax.
- Cumulative Net Investment Loss (CNIL) — You will not be able to claim your capital gains exemption to the extent that you have a CNIL balance. A CNIL is the cumulative total of your investment expenses less your investment income since 1987.
- Allowable Business Investment Losses (ABILs) — You may not be able to claim your full capital gains exemption to the extent you have claimed any ABILs in past taxation years.
- Other Benefits and Credits — Employment insurance and other benefits will be clawed back when your net income exceeds a certain threshold. For purposes of determining these benefits, taxable capital gains increase your net income, even when the exemption is claimed. The same issue arises when determining whether you are eligible for certain provincial tax credits, as eligibility depends on the level of your net income.
Talk to your BDO advisor before you trigger any capital gains to ensure that you understand the impact that these gains will have on the above.