In recent years, farmland prices have increased significantly across many parts of Canada. At the same time, the average age of the Canadian farmer has risen as well, leading to many farms being transferred to next generations or sold to third parties.

Farmers selling qualified farmland can claim the lifetime capital gains exemption (CGE) of up to $1,000,000 without paying tax. But when claiming the CGE, farmers should be aware that alternative minimum tax might apply.

What is alternative minimum tax?
The alternative minimum tax (AMT) is an alternative way to calculate taxes owing in Canada when an individual experiences preferential tax deductions. The Canada Revenue Agency introduced the AMT to guard against situations in which high-earning individuals might be in a position to pay little or no tax by using certain deductions to reduce large portions of their income.

When is AMT payable?
Most commonly, a farmer must pay AMT when claiming the CGE on their personal tax return as a result of a sale of qualified farm property. The capital gain resulting from the sale is included in the farmer’s total income, and the CGE is a deduction that is applied when calculating the farmer’s taxable income. The calculation for AMT uses total income rather than taxable income when determining the amount that is payable in the year.

Consider the example of a farmer who has sold their farm and is claiming the full $1,000,000 CGE. The AMT amount that could arise ranges from $31,000 to $60,000, depending on the province of residence. This liability can come as a bit of shock to a farmer expecting to be able to shelter all or part of the capital gain from the sale of a farm. It can also impact significantly on expected cash flows for retirement.

However, there is some good news regarding AMT. The tax should be treated as a tax instalment that is prepaid in the year of the capital gain. AMT balances that have been paid may be recovered as credits against future taxes within seven subsequent years. A farmer who is still generating taxable income after selling a farm may recover the AMT paid in the year the capital gain was triggered.

Reducing AMT
Farmers may be able to take advantage of some tax planning strategies in the year a large capital gain is incurred.

Capital gain reserves
If a portion of the capital gain is deferred using a reserve, the total income in the year will be lower and the amount of AMT in each year will be reduced. A capital gain reserve permits a farmer to defer the gain over five years if a farm is sold to a third party, or up to ten years if it is sold to a related party. In order to qualify to use a capital gain reserve, a portion of the consideration received for the qualified farm property must remain outstanding. 

Net capital losses
Individuals should regularly review their most recent notices of assessment to confirm that they have carried forward all available capital losses. Capital losses may be carried forward indefinitely and may be applied to reduce taxable income, thus reducing the capital gains exemption and the AMT. However, if an individual locks in the CGE on qualified farm property and plans to use the full $1,000,000, AMT is not reduced. Essentially, carrying forward capital losses simply increases the cost base of the property rolled over, as the intention is to use the full exemption.

Getting AMT back
As discussed above, taxpayers have up to seven subsequent years to claim AMT back as a credit against taxes payable after the AMT was paid. A taxpayer seeking to make such a claim must have sufficient taxable income to generate taxes payable. If there is not enough taxable income generated in the seven subsequent years, the remaining AMT balance is lost and becomes a true tax cost to the taxpayer.

Depending on a taxpayer’s unique circumstances, other tax planning strategies might be available to help recover the AMT balance. Obtaining professional tax advice is recommended.

RRSP and RRIF withdrawals
Increasing planned withdrawals from RRSPs and RRIFs in order to generate higher taxable income and therefore more taxes payable can be beneficial. This strategy will reduce the time required to use up the AMT balance and will essentially get money out of these funds “tax free.” The money may then be used to fund retirement plans (e.g., travel) or to invest in other avenues (e.g., TFSA).

AgriInvest withdrawals
Taxpayers who have been waiting to withdraw funds from AgriInvest should consider doing so now to trigger the taxable portion of the fund, to increase taxable income, and to accelerate the AMT payback.

Effect of death on AMT
AMT does not apply in the year in which a taxpayer dies. No AMT applies where qualified farm property is disposed of on a final return. Such a case presents the opportunity to dispose of the property at fair market value on the taxpayers’ final return, and to use the full remaining CGE to increase the cost base of the property for the next generation.

The rules governing capital gains and the use of the capital gains deduction are complex. When you are ready to talk about selling your farm or transitioning to the next generation, call your Baker Tilly advisor. We can help plan your transition and ensure you benefit from all appropriate tax minimization strategies.