For family farm operations to prosper into the future, it is important to have successful transfers from one generation to the next. Many tax and non-tax issues must be considered to implement a successful farm succession plan. Those issues include:

• Will the parents transfer complete ownership?
• How will management decisions be made?
• If the parents are retiring, what are their income expectations?
• Can the farm afford to pay off any debt the parents take back on the transfer of ownership?
• How will non-farming children be treated?

Many tax rules can affect farm transfers, both before and after the death of the transferor. Family dynamics will also impact on the success of a succession plan.

Tax issues

Transfer of farm property prior to death

The basic rule governing asset transfers to children for proceeds less than fair market value dictates that the parent is deemed, for tax purposes, to have disposed of the property at fair market value. However, for the transfer of farm property (which includes land, depreciable property and eligible capital property such as quota, but does not include inventory), a special rule exists. Providing that the farm property was, before the transfer, used principally (more than 50 per cent) in the business of farming, and where a family member was actively involved, the assets may be transferred at cost, fair market value, or any value in between. For depreciable property and quota, the lower threshold will be the undepreciated capital cost. The ability to transfer at any price up to fair market value provides flexibility in maximizing the tax position of the parent and the child, particularly since there is also a mechanism that allows for the property to transfer back to the parent without tax consequences if the child were to die unexpectedly.

If any capital gains are triggered, the $1,000,000 capital gains exemption could be available to offset the gains.¹ An increase to the cost base of depreciable property (including quota) in a non-arm’s length transfer, regardless of using the capital gains exemption, invokes special rules to prevent the full increase from being available for future tax depreciation by the child. However, the increased amount or cost will be used to calculate any future capital gains the child may have on a subsequent sale or transfer.

Transfer of farm property upon death

Generally, upon the death of a taxpayer, the taxpayer is deemed to have disposed of all assets immediately before death. However, a number of provisions allow properties to be transferred at cost so that no immediate taxes are owed.

Special rules permit the transfer of a farm property, upon the death of a parent owner, to a child at cost, fair market value, or any value in between. An additional technical condition requires that the farm property must “vest indefeasibly” to the child within 36 months of the parent’s death. Essentially, the child must have absolute ownership with no strings attached within 36 months of the parent’s death.

Inventory

No special provisions exist to allow farm inventory to pass between parents and children without tax. For transfers to children, often a cash basis note is taken by the parent (assuming cash basis reporting is used for tax purposes). Such a note allows the parent to take into income the value of the inventory only as payments on the note are received. Likewise, the child takes a deduction only when payments are made.

Capital gains exemption

Access to the $1,000,000 capital gains exemption on qualified farm property for the parents is always a consideration when a transfer is contemplated, though succession planners should not assume access to the exemption is available or beneficial. A full review of the exemption criteria is necessary, and the often-conflicting objectives of affordability and increasing the cost base for the children must be resolved. Other issues include the triggering of minimum tax and repayment of social benefits, such as OAS. Again, proper planning can reduce or eliminate these adverse consequences.

Family dynamics

While tax considerations certainly are important in any succession plan, one cannot ignore the impact of the family dynamics. Family business advisors indicate that more than 80 per cent of family business transition failures can be attributed to the lack of awareness of and/or the inability of business families to adequately address family dynamics.

Working together as a family can provide many advantages, such as a shared history, awareness of one another's strengths and weaknesses, and trust and care for each other. Families who learn to work well together can have successful businesses now and into the future.

However, there are also challenges. The ability to communicate effectively, to resolve conflicts, to make decisions, and to differentiate the family and the business can have a profound effect on the success of the business.

The potential for conflict among family members and between generations is most likely to surface during three key periods:

• the successor’s entry into the family business;
• the succession planning process; and
• the retirement of the founder.

Communication

Communication, or lack thereof, is a common problem for families in business together. Family members who work together face the added difficulty of needing to communicate on three distinct levels:

1. as family members on an emotional level;
2. as owners on a strategic level; and
3. as managers on an executive level.

These requirements can be challenging. Regular family/business meetings can greatly improve communication, which in turn can increase productivity and build strong relationships.

Founders

In some cases, founders have difficulty “letting go.” They struggle with discussions about succession, they resist giving up control, and they refuse to make contingency plans for the business. The inability to let go can be harmful to the family, the business and succession.

Following are some reasons founders have given for why they struggle to let go:

• Nobody can run the business as well as I can.
• The business is my major source of income; I need to protect it.
• I have more than one capable child who can take over and I don’t want to have to choose.
• I need someplace to go.
• The children want to change the way the business is run.
• I don’t know what I’ll do after retirement. I have no hobbies or other interests.
• People don’t live long after retirement.

In order for the business to succeed during and after succession, founders must accept the fact that it is time to begin transferring the business to the next generation.

Farm family styles

Recognition of different “business styles” can help when two or more individuals are working together. Research has identified two fundamental approaches to farming: the “expander” and the “conservator.”

Expanders have entrepreneurial drive, high ambition, vision and high need for control. They are greater risk takers, willing to leverage to expand their business. Retirement is not planned.

Conservators tend to achieve success through hard work and a more cautious approach to debt and expansion. They often pass their farms down to the next generation with little or no debt. They tend to plan for retirement, making succession much easier.

 

Thomas Blonde
Elora, Ontario
D (519) 846-5315 ext. 319
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