When a family farm operation has been incorporated, it is relatively common for the family residence to be on the same parcel of land as the farmland owned and operated by the corporation. The situation can present a number of traps for the unwary:

1. The principal residence exemption may not be available on an eventual sale of the family residence.
2. Benefit conferral rules may deem a taxable benefit upon the residents of the home in certain circumstances.
3. The use of the capital gains deduction for the family farm corporation’s shares may be compromised.
4. The ability to access the tax-free intergenerational transfer provisions may be at risk.

Principal residence exemption

The principal residence exemption is available only to Canadian resident individuals. As a result, corporate ownership of a family residence will eliminate the option to use the principal residence exemption against any gain on the sale of the residence.   

Where it is desirable for the farmland to be owned by the corporation, and where the land upon which the residence is immediately situated cannot be severed into a separate and distinct legal parcel, the loss of the exemption with respect to future appreciation of the residence may be an unavoidable ‘cost of doing business’ in order to achieve the benefits of incorporation.   

Where retaining access to the principal residence exemption is of particular concern, these matters should be discussed with your local Baker Tilly advisor.    

Benefit conferral rules

Where corporate property is made available for the personal use of a shareholder of a corporation (and/or parties related to a shareholder), such as when use of the farm residence is provided by the family farm corporation to the shareholder’s family, a taxable benefit may be deemed to be conferred upon the shareholder, generally equal to the fair market value of the rent the corporation could have obtained by renting the property to a third party. 

However, a general limitation within section 18 of the Income Tax Act stipulates that outlays or expenses of the corporation are only deductible to the extent they are incurred for the purpose of gaining or producing income. In the example above, this purpose test will not be met. Consequently, the corporation will be allowed no deductions for the ongoing expenses of maintaining the residence. Given taxable income to the individual shareholder and a lack of deductions to the corporation, the result amounts to double taxation.

In theory, when use of the farm residence is provided by the family farm corporation to the family in their capacity as employees rather than as shareholders, it may be possible to avoid shareholder benefit conferral. However, it is risky to rely on such an interpretation as there will be a presumption that the residence is provided to the family members in their capacity as shareholders. It may be appropriate to have the family farm corporation charge the family fair market value rent to avoid the risk of double taxation.

Capital gains deduction and tax-free intergenerational transfer provisions

Perhaps the most significant potential traps for corporate-owned farm residences relate to the capital gains deduction and tax-free intergenerational transfer provisions. The capital gains deduction may provide the individual taxpayer with a deduction of as much as $1 million to offset a gain on the sale or transfer of the corporation’s shares. The tax-free intergenerational transfer provisions allow, under certain circumstances, for the transfer of family farm corporation shares during the life, or at the death, of the owner to certain related parties, including children and grandchildren. 

However, in order for these key provisions to be available to provide relief to the individual taxpayer, the corporation itself must meet certain technical tests, which may be greatly impacted by the existence of a farm residence within the corporation. For example, at the time of sale or transfer, 90 per cent or more of the fair market value of the assets owned by the corporation must be attributable to property that was used “principally” in the course of a farming business in Canada. To the extent that the residence is not used principally for this purpose, the ownership of the residence by the corporation may imperil the use of these key provisions.

Consider a simple example where the farm house is not used principally in the course of a farming business in Canada. Assume the following fair market values of the corporation’s assets:

At these values, the corporation no longer meets the 90 per cent test because the fair market value of the house and contiguous land is more than 10 per cent of the total fair market value of the corporation’s assets. Accordingly, the capital gains deduction will not be available to offset a capital gain on a sale or transfer of shares, and the corporation’s shares will not meet the requirements for tax-free intergenerational transfers. This issue may be particularly relevant where the shares of a family farm corporation are being passed to a child or grandchild upon the death of a parent or grandparent.

Summary

There are many potential tax risks involved in having a family farm corporation own a farm residence. However, it may at times be unavoidable. If the residence must be owned by a family farm corporation, be sure to consult your local Baker Tilly advisor to ensure that ownership is structured appropriately and the related risks managed prudently.

Particular care should be taken to consider that the corporation is a distinct legal entity and that, as much as possible, the corporation should hold only assets used principally in the farming business. Non-farming assets should be structured in another way to ensure the use of the capital gains deduction is not at risk, and that the ability to qualify for tax-free intergenerational transfers is not compromised.

Please contact your local Baker Tilly advisor with any questions or for additional information.