Cut your tax bill by selling farmland strategically
Many farms are owned personally, often as a sole proprietorship or a partnership between two or more individuals. When a farm is transferred to the next generation or sold to a third party, the seller is taxed on the capital gain. Alternatively, if the land is owned inside a company, the individual may sell shares of the company that owns the land. In that case, there would also be a capital gain recognized personally on those shares. Based on the way increasing marginal tax rates currently work, if you sell everything at once and get taxed for it in a single year, you will creep into higher personal tax brackets than if you spread this sale out over multiple years.
However, if you have enough to cover your cash needs each year, and you’re willing to spread that gain over several years, you will be able to keep this income out of those higher tax brackets. Whereas a buyer would typically get financing from the bank and pay the full amount owing in one payment, the idea here is for the buyer to make payments to you over several years. For most buyers, this gradual payment approach is easier and therefore preferable, depending on the terms of the loan for annual financing. The more time you give the buyer to pay you back (up to five years), the smaller the gain and the lower your taxes will be each year. Still, there are some other complications to consider.
Alternative minimum tax
While this gradual payment approach has obvious benefits, some would argue the capital gains exemption could make it unnecessary to reduce your tax bill, as long as your gain falls below the $1 million exemption limit. However, it still might make sense to split the payment over several years because, even if the capital gain exemption protects you from paying tax, you could still end up paying alternative minimum tax (AMT). This arises in some cases where your net income is high, but your taxable income is quite low. The lifetime capital gains deduction reduces taxable income, but not net income. If you’re able to split the gain over multiple years, you can sometimes lower the AMT or get rid of it altogether, depending on a variety of other factors.
Old Age Security
Another important issue to consider is the age of the person selling the farmland. If the seller is 65 or older, they might be receiving Old Age Security (OAS), which is roughly $7,500 a year, but there’s a clawback on that OAS amount if your net income exceeds a certain threshold ($81,761 for 2022). Typically, in the year of a sale, there’s a capital gain that pushes the seller’s income higher for that year, forcing them to repay their OAS and miss out on this the following year. However, if we split that gain over multiple years and keep their income under that threshold annually, they might never have to repay their OAS.
Selling to the next generation
In farm succession situations, you sometimes have a seller who wants to sell to the next generation at a reduced price (less than fair market value). We often tell them to sell for the full price and pay tax on the capital gain, using the capital gain exemption, while also spreading payments over several years (up to 10 years in some cases), so it has no major impact on their personal income. The buyer would then get that higher cost base, which only helps them in the future. If the intention is to only ever collect a reduced amount, the seller can forgive part of the amount owing in their will as part of their estate plan. That would mean the amount never has to be paid by the successor, but they still benefit from the increase in cost base.
Luc Joye
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Luc Joye