Rights or things: Farm inventory on a cash basis
When a farmer who operates a farm through a proprietorship – that reports income for tax purposes under the cash method – passes away, there are a number of options available for how the farm inventory left behind will be treated for tax purposes. It is very important that executors of the estate understand the options available to them. This alert addresses tax planning options that are often overlooked when dealing with the estate of a farmer.
Five possible treatments for farm inventory
An executor generally has five options regarding the taxation of farm inventory that was accounted for on a cash basis. Note: all statutory references below are to the Income Tax Act (Canada).
1) Tax the fair market value of the farm inventory on the final tax return
The fair market value of the inventory immediately before death is taxed as farming income on the final personal tax return, as required under subsection 70(2). The beneficiary receives the inventory at a cost equal to its fair market value on the date of death under paragraph 69(1)(c).
2) Elect under subsection 70(2) to file a separate rights or things return
The fair market value of the inventory immediately before death may instead be taxed on an optional and separate tax return of the deceased, commonly referred to as a “rights or things return”, which has its own marginal tax brackets and is eligible for certain personal tax credits. This optional return must include the total value of all the decedent’s rights or things, other than those transferred to beneficiaries within the time provided by subsection 70(3). This means that a decedent’s rights or things cannot be split between the final return of the decedent and a rights or things return, as it is an “all or nothing” election. The due date for this election is the later of one year after the date of death and the day that is 90 days after the sending of any notice of assessment for the year of death. As with the first option above, the beneficiary receives the inventory at a cost equal to its fair market value at the date of death under paragraph 69(1)(c).
3) Transfer all rights or things to beneficiaries
If all rights or things of the deceased are transferred or distributed to beneficiaries of the estate before the time for making an election under subsection 70(2) expires, the taxation of these rights or things upon death – including the inventory – is deferred under subsection 70(3). The application of subsection 70(3) is automatic, so no election is required for this option. The beneficiary receives the inventory with a cost for tax purposes equal to that of the decedent under subsection 69(1.1). The beneficiary receiving the inventory realizes farming income in the taxation year in which they receive payment for sale of the inventory.
4) Do not elect under subsection 70(2) and transfer some of the rights or things to beneficiaries
Taxation of the farm inventory that is transferred to a beneficiary may be deferred as a result of the same provisions identified in the third option above, provided that the transfer occurs before the time for making an election under subsection 70(2) expires. The fair market value of any farm inventory not transferred to a beneficiary is taxed as farming income on the final personal tax return of the decedent.
5) Elect under subsection 70(2) to file a separate rights or things return and transfer some of the rights or things to beneficiaries
Taxation of the farm inventory that is transferred to a beneficiary may be deferred due to the same provisions identified above, provided the transfer occurs before the time for making an election under subsection 70(2) expires. The fair market value of any rights or things not transferred to a beneficiary would be taxed on the separate rights or things return.
Planning opportunities to consider
Having a good understanding of the available options with respect to the taxation of farm inventory will help executors maximize the after‑tax value of an estate. For example, the farmer may have unused losses in the year of death or carried forward from prior years.
- To use these losses, executors should consider not electing to report the inventory on a separate rights or things return and instead reporting it on the final personal tax return.
- If available losses are not sufficient to offset the full value of the inventory, the executor could leave the remaining inventory to be taxed on the final return or choose to defer tax by transferring the excess inventory to a beneficiary who may benefit from a lower marginal tax rate.
- Alternatively, the executor could elect to have the inventory taxed on a separate rights or things return. In this way, the inventory value would be brought into income with a new set of marginal tax brackets and with certain personal tax credits.
- Executors have some control as to how much inventory value is brought into income on the rights or things return, as they can defer tax on any amount of inventory transferred to the beneficiaries before the deadline.
Another consideration is that prior year mandatory and optional inventory adjustments of the farmer will be deducted in the final tax return of the deceased taxpayer regardless of what option is chosen. If the value of farm inventory is not taxed on the final personal tax return – either because taxation is deferred by transferring the inventory to a beneficiary or because it is included on a separate rights or things return – these inventory adjustments may result in a farm loss on the final tax return. If this loss cannot be applied to reduce the income on the final personal tax return of the deceased or carried back to recover taxes paid in the prior three years, some or all of the farm inventory should be taxed on the final personal tax return. Optional and mandatory inventory adjustments to increase farming income are not available in the year of death.
With the right planning, the family may realize significant tax savings. However, the best course of action may not always be obvious. Contact your Baker Tilly advisor to determine the correct planning for your circumstances.
Meet the Author
Kale Donald
Information is current to December 20, 2022. The information contained in this release is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation.