Favourable tax treatment for land clearing and drainage

The tax treatment of clearing and tile drainage of agricultural land differs based on the ownership and use of the land. This article discusses the treatment under the most common scenarios. Compared to other businesses, farmers receive favourable tax treatment for these types of expenditures. 

Typical tax treatment

Clearing – If land is cleared in order to construct a building, the CRA dictates that the clearing costs form part of the cost of that asset. If the clearing does not relate to construction of a building, the costs form part of the adjusted cost base of the land. 

Tile drainage – Tile drainage is considered depreciable property and is included in Class 8, which has a capital cost allowance (CCA – tax depreciation) rate of 20 per cent. 

Favourable tax treatment for farming businesses

Section 30 of the Income Tax Act permits the deduction of “clearing land, levelling land or installing a land drainage system”¹ in calculating a taxpayer’s income from a farm business. Section 30 also includes the wording “to the extent that the amount has not been deducted in a preceding taxation year,” which permits a farmer to carry forward a portion of the cost to a future taxation year(s) if the full expense is not necessary or desired in the year paid.² If the land was cleared in order to construct a building, this cost must be capitalized to the building subject to subsection 18(3.1) of the ITA. 

Consider the example of an Ontario farmer who spent $100,000 in the spring of 2018 on tile draining a parcel of land that was formerly pasture. The combined 2018 corporate tax rate was 13.5 per cent.³ In the absence of section 30, the tile drainage would be an addition to the Class 8 UCC pool, eligible for CCA at a rate of 20 per cent, and subject to the half-year rule in the year of acquisition. (If the tile drainage had been installed in late November, it would have been eligible for the accelerated CCA discussed in the recent Tax Flash.) If the expense was included in class 8, the tax savings for 2018 would be $1,350 ($100,000 of tile drainage x 20 per cent CCA rate x 50 per cent for half-year rule x 13.5 per cent corporate tax rate). With the full deduction available under section 30, the tax savings for 2018 would be $13,500 – ten times the savings compared to treatment as depreciable property ($100,000 of tile drainage x 13.5% corporate tax rate).

The savings are that much more significant at higher tax rates.  

As outlined above, section 30 accelerates the write-off of “tile drainage” expenditures from 20 per cent CCA per year⁴ to a full deduction in the year paid. For “clearing,” section 30 permits the full write-off of non-deductible expenditures that would otherwise be capitalized to the cost base of the land. While deducting tile drainage rather than claiming CCA at 20 per cent merely speeds up the deduction, the tax differential for clearing is more dramatic. If treated as an addition to the cost base of the land, the amount is never deductible. The outlay will not provide any tax benefit until the property is sold. On sale, it will reduce the capital gain on the property. With a capital gains inclusion rate of 50 per cent, the strategy still provides only half the benefit compared to a deduction once the property is sold. 

Rented land – tenant

The provisions in section 30 do not hinge on the ownership of land, but rather on carrying on a farm business. A taxpayer farming a parcel of land as a tenant is still eligible to deduct the full amount paid for clearing and/or draining the land. 

Owned land – rented to a farmer

Since a landlord is not in the business of farming, the standard, less-favourable tax treatment applies. Land clearing is an addition to the cost base of the rented land, and tile drainage is a Class 8 asset eligible for CCA at a rate of 20 per cent. 

An agricultural landlord considering a land clearing and/or drainage project may renegotiate a lease with a tenant to make the project more tax-efficient for both parties. 

As an alternative to the landlord paying for the project, the costs could be incurred by the tenant, who would then be entitled to work the land rent-free or at a reduced rental rate for a period of years. For example, if tile drainage would cost $1,000 per acre and the current annual lease rate is $100 per acre, the tenant farmer could receive ten rent-free years in exchange for tiling the property. 

Purchase of already tiled land

The CRA and the tax courts have also addressed the tax treatment of the purchase of previously tiled land. In an interpretation bulletin, the CRA stated that the full purchase price of tiled land relates to the land itself, and no portion is eligible for treatment as a depreciable asset. In (TRB) Matheson v MNR,⁵ the Tax Review Board considered the deduction under section 30 of previously installed tile drainage. The farmer had purchased a property and had deducted an amount based on his estimate of the fair market value of the existing tile drainage, which the previous owner of the land had installed a number of years earlier. The CRA denied the deduction. The court agreed with that position, holding that the deduction could only be claimed by the farmer who paid for the installation of the drainage system, not a subsequent purchaser of the land.

The tax benefits to farmers improving land can be substantial. Contact your Baker Tilly advisor to discuss how these provisions can affect your farm.