Sell the cow... pay the tax...

Sell the cow... pay the tax...
by Perry Pellegrini - 5, 2008

In one of my previous articles we outlined how the various farm assets are taxed when sold. We've seen that inventory is fully taxable when sold and recaptured CCA (depreciation) is also taxable when assets are sold.

Unlike capital gains, which are only partially taxed, inventory and recapture are included fully in income for the year. The problem, of course, is that in the year of sale, these tend to be fairly large amounts, pushing you into the top tax bracket. The challenge is to find ways to get this income taxed at a lower rate.

If you anticipate taxable income levels to drop significantly in the years after your sale, there are several deferral options you can pursue. With grain receipts you can choose to take a deferred ticket, but that will typically only push the income off one tax year. If you're selling cattle to someone you know, you could take payment over time through something called a "producer note", which acts like a deferred ticket, but can span several years.

In many situations though, where you can't control deferral of the initial payments, you may consider buying inventory to manage income. This approach can help defer the recapture depreciation as well. Essentially you would purchase enough inventory to bring taxable income down to a manageable level for the current tax year. Since farmers typically file tax on a "cash basis", the purchased inventory becomes an expense, and is deductible against income.

The most effective way to do this in Alberta, is to buy feedlot cattle. In most cases this will ensure you meet Canada Revenue Agency's (CRA's) requirements of actually owning the inventory while avoiding physically having to deal with it. Whatever amount of inventory you buy will become income next year. The process can be repeated each year until all of the farm income has been taxed at appropriate rates. Remember though, this really only works if you expect taxable income to drop in the years following your sale.

You may be able to reduce income through salaries to spouse or other family members. You could also pay employed family members a "severance package", since their employment will be ending, now that the farm is sold.

The financial world offers tools as well. You could buy energy or mining "flow through" shares. These are situations where the money you pay to buy shares, will be used by the company to explore for oil, gas or minerals. CRA allows a full deduction for these types of expenses, and since many of these "exploration" oriented companies don't currently have income to use the deduction against, CRA allows them to "flow through" the deduction to the people that bought the shares.

Typically, the shares are redeemed, bought back, or sold within two years. Since you originally wrote off the purchase price, the proceeds you receive when sold, are considered to be a capital gain. Only half of a capital gain is taxable, so the strategy effectively cuts your tax bill in half, assuming you sell the shares for the same price you paid. I do caution you here. Flow through shares are complicated structures and considered risky. Do not go down this road without professional advice on the investment, and the tax consequences.

Finally, you could incorporate your farm before selling the assets. There are several approaches to moving your farm assets into a corporation in advance of a sale. The net benefit is to move away from the top personal tax rate of 39% and access the small business corporate tax rate of 14.1%.

This process can be extremely rewarding, but it is not without costs and complexities. While it can be done quickly, before an already planned sale, it is advantageous to pursue this strategy a year or two before a sale. Due to costs involved, there may be a size threshold to using a corporation. In effect, you want to explore all other options first to see if they can solve your taxable income problems; if not, then look at incorporating.

Managing your taxable income through a farm asset sale is a function of identifying the planning options that are relevant in your situation, evaluating how you would implement them, measuring the costs associated and the benefits expected. Based on that approach you will be well equipped to determine a course of action that will keep more money in your pocket.

The sale of farm assets and various strategies that can be employed involve complex legal and tax issues. It is very important that you obtain professional advice.

Perry is a senior partner with Pellegrini LeBlanc in Red Deer, AB which focuses on farm sale and financial planning throughout Alberta.