A pound of flesh

A pound of flesh
by Perry Pellegrini - 3, 2008

The sale of farm assets, including: land, buildings, machinery, equipment and inventory will give rise to tax. How the taxes are calculated varies by asset type. In this article we will look at how each asset is taxed when it is sold.

Your land typically will give rise to a capital gain. The capital gain is the difference between Net Proceeds and your Adjusted Cost Base. Net Proceeds is your Sale Price less any costs of sale, such as commissions and legal fees. Your Adjusted Cost Base is usually the amount you paid for the land. There are some events that could cause adjustments to your cost during the time you own the land, hence the terminology "Adjusted" Cost Base (ACB). It is wise to consult your accountant to confirm your ACB on any piece of land.

The capital gain is not all taxable. The current "inclusion rate" is 50%, which means only one half of the capital gain has to go on your tax return. As an example, if you sold land for $850,000 that you paid $100,000 for, many years ago, you would have a capital gain of $750,000. One half of this amount, $375,000, would go on your tax return as a "taxable capital gain".

If the property has been owned jointly between husband and wife, the capital gain would be split between them and each would record $187,500 as taxable capital gains (in the example above).

These are rather large amounts of "income" that show up on the tax return. Without the benefit of any planning opportunities or exemptions, this income will attract tax at the higher marginal tax rates. In Alberta, the top personal tax rate is 39%. In the example above, the income payable on a $750,000 capital gain ($375,000 taxable) could be as much as $146,250.

Buildings are capital assets, but are considered "depreciable". This means that you are claiming a portion of the cost of the building as an expense each year. That portion is referred to as a "Capital Cost Allowance" or CCA.

As you claim Capital Cost Allowance against what you paid for the buildings, you track something called "Unused Capital Cost" (UCC). This usually shows up in the last column on the right in you Capital Cost Allowance Schedule of your income tax return; buildings are reflected in the "Class 6" category.

When you sell your farm, the portion of the sale price attributed to the buildings (excluding the farm home, as it is your principal residence) will be used to calculate recaptured CCA (depreciation) and capital gains. Typically, buildings do not sell for more than what you originally paid for them, so capital gains are rare.

The amount you receive for the buildings that exceeds your Unused Capital Cost (UCC) is considered a recapture of Capital Cost Allowance and is taxable as active farm income.

For example, if the building value in your farm sale is $100,000, and the UCC value of your Class 6 pool is $40,000, then you will have $60,000 of this sale being taxable as income.

The farm home may be exempt from tax if it is your principal residence. If not, it may be a part of your Class 6 pool. It is also possible to have it partially exempt and partially taxable, depending upon how you have used it through the years and what expenses you have claimed. It is important to review this issue prior to a sale.

Machinery and equipment
"Machinery" generally refers to self-propelled equipment and "Equipment" is not. Both are treated similar to buildings when they are disposed of. They are, however, maintained in different Capital Cost Allowance pools. Self-propelled equipment is Class 10 and the rest is Class 8.

Over the years you claim CCA and track a UCC balance. When you sell these assets, it is typically for more than the UCC value, but less than original cost. As with the buildings, if you sell for more than you paid, that portion is a capital gain. The other portion of sale price above your UCC value is considered recapture of CCA (depreciation) and is taxable as farm income.

Inventory includes grain, livestock, feed, fertilizers, etc.

Farmers typically file their taxes on a "cash basis", which means you don't pay tax on the sale of inventory until you sell it, and receive the money. It also means that you claim an expense for all items of inventory when you buy them and pay for them.

The result of this is that when you retire, all inventory on hand will be sold, creating taxable income, but without the offsetting expenses for input costs that are associated with an ongoing operation.

There are two scenarios that may reduce the amount of inventory sales taxable as income, Mandatory Inventory Adjustment or Optional Inventory Adjustment. Mandatory Inventory Adjustment (MIA) is created during years where you created a farm income loss, and that loss was attributed to you "buying inventory". In other words, you bought physical inventory and expensed it, which put you into a loss position. The amount of inventory purchased that created the loss will essentially be disallowed (hence the term "Mandatory") and will be tracked, so that when you sell that inventory it is not taxable.

Optional Inventory Adjustment (OIA) is used when you choose to pay the tax on a portion of your inventory, even though you haven't sold it. This would happen when you wish to manage your taxable income each year to a target amount, ensuring for example that you make use of the lowest tax brackets. To the extent you have OIA, that portion of inventory sales would not be taxable, since you chose to pay tax in a previous year.

Please note that this discussion of how the sale of farm sale assets is taxed is general in nature. Every farm operation is different, and your operating structure can significantly impact the taxation of the various assets. Make sure you consult your advisor before taking any action.