When a farmer ponders a change in pace in his or her operation, land rental could be an option
By Kate Ayers
For producers who are considering renting their farmland out, “the tax consequences of this situation will differ for each individual,” said James Peterson, president of Southwestern Tax Service in St. Thomas, Ont. and chair of the Association of Tax & Accounting Professionals. Generally, however, taxes will “be determined by how you own the land you are renting.”
Tax authorities, such as Canada Revenue Agency, classify farmland rent as investment (or passive) income since it is not a farming activity. The specifics of how an accountant will deal with this income depends on whether the land is held inside or outside of a corporation.
“If you hold your land inside a corporation, your rent income will be considered passive income and will be subject to additional refundable tax on investment income,” Peterson said to Farms.com in an email statement.
“In Ontario, this income would bring your initial tax rate in excess of 50 per cent, although part of that would be refunded upon payment of dividends to shareholders.”
If a farmer in a corporation has passive income over $50,000, he or she will be less able to claim the small business rate. As a result, the producer may also be taxed at the higher general rate for any active business income, Peterson said.
“Passive income and investments inside a corporation could also restrict your ability to claim the qualified farm property (QFP) exemption on the sale of your shares,” he added.
QFP is part of the lifetime capital gains exemption available to individuals on the disposition of farmland, quota, shares of a family farm corporation or an interest in a family farm partnership. The rules around when and how you claim this exemption can be quite complex, so it would be in the farmer’s best interest to contact a qualified tax professional, Peterson suggested.
“But most farmers with a corporation will never sell the shares to anybody other than a family member – they usually end up selling the land inside the corporation and dealing with the tax consequences,” he added.
“In this situation, one-half of any resulting capital gain is treated as investment income and taxed at the higher rate. The remaining half can be flowed out tax-free to shareholders via a capital dividend.”
For land that is owned by an individual, by joint tenants or tenants in common, rental income tax implications are not immediate but could present challenges in the future.
“If you hold your land outside your corporation and report the rent on your personal T1 return, this distinction between active and passive income will not result in any immediate negative tax consequences. It could, however, possibly affect your ability to claim the qualified farm property exemption in later years,” Peterson said.
“On your personal T1 return, there is no distinction made between investment income and other types of income. Rather, you would pay tax on your net profit on the rental at your marginal tax rate.”
For farmland owners outside of a corporation, land rentals will have similar tax implications to farming the land yourself. But producers cannot write off some expenses against a rental that they could apply to active farming income.
“The notable expense is tiling,” Peterson said.
“If you are renting out your land and you tile it, that cost cannot be expensed in the current year or through the capital cost allowance system. It must be added to the cost of the land. This rule applies whether you hold the land inside or outside a corporation.”
If a producer is worried about the tax consequences of renting out his or her farmland, he or she has two options.
First, a farmer can work with his or her accountants to develop a crop share arrangement. The agreements must meet the following list of criteria, so the income is still considered farm income for tax purposes
- the landlord assumes risk on the production and marketing of the crop
- the landlord is active in the production and management of the crop
- the landlord supplies inputs for the crop
- compensation fluctuates and is not a set price per acre
The second option is a custom work arrangement.
In this situation, “the farmer supplies all the inputs and receives all of the crop but pays somebody to look after all of the field work,” Peterson said.
“Similar to a valid crop share arrangement, this deal means that the farmer assumes risk on the production and marketing of the crop, as well as the key management decisions related to the crop.
“While this type of arrangement is not as popular as crop sharing, more retired farmers are considering this option as it avoids the objections that the Canada Revenue Agency raises with many crop share deals,” he added.
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