Unsure if you can deduct your farm losses? The rules have changed!
When farm losses are incurred by a taxpayer, they may be non-deductible, restricted or fully deductible depending on what class the taxpayer falls under based on the farming activities performed during the year. The classes are as follows:
The taxpayer’s chief source of income is farming, or a combination of farming and some other source of income.
Any farming losses incurred by the taxpayer are fully deductible against all types of income.
To be the chief source of income, the farm must be a business carried on with a reasonable expectation of profit. In addition to gross and net income of the farming business; capital investment, cash flows, personal involvement, future development plans etc. should be considered.
The taxpayer’s chief source of income is not farming or a combination of farming and some other source of income, but he/she still carries on a farming business.
Any farming losses incurred by the taxpayer are restricted, or partially deductible.
Again, the farm must be a business carried on with a reasonable expectation of profit. To determine deductibility, the following are also considered:
- Extent of activity/size of property
- Time spent on farming operations compared to other employment or income earning capacity and/or time spent on farming during regular farm seasons
- Development of the farming operations and future plans for expansion, including intention to implement those plans
- Qualification of the taxpayer for provincial farming assistance
The taxpayer’s chief source of income is not farming or a combination of farming and some other source of income and he/she carries on some farming activities but has no reasonable expectation of profit from those activities.
Any farming losses incurred by the taxpayer are not deductible and are considered to be personal expenses.
Common indications that the business does not have reasonable expectations of profits include having no, or very minimal, gross income for several years without any circumstances that would warrant such low income (such as starting a new farming business or prolonged extremely adverse weather conditions).
Restricted farm losses:
For the second class outlined above, restricted farm losses can be claimed against other types of income to a maximum of $8,750 for tax years ending March 20, 2013 or before. For tax years ending after March 20, 2013, the maximum amount of farm losses that can be claimed increases to $17,500.
Calculating restricted farm losses prior to March 21, 2013:
For net farm losses greater than $15,000, the deductible portion of the farm losses will be $8,750.
For net farm losses less than $15,000, the deductible portion of the farm losses will be the lesser of:
- The net loss incurred during the year, or
- $2,500 plus 50% of (the net farm loss minus $2,500)
Calculating restricted farm losses after March 20, 2013:
For net farm losses greater than $32,500, the deductible portion of the farm losses will be $17,500.
For net farm losses less than $32,500, the deductible portion of the farm losses will be the lesser of:
- The net loss incurred during the year, or
- $2,500 plus 50% of (the net farm loss minus $2,500)
The above are used to calculate the deductible portion of farm losses. Any losses in excess of this calculation are restricted farm losses. These losses can be carried back 3 years, or carried forward 10 years for losses incurred 2005 or earlier, or 20 years for losses incurred after 2005.
When carrying back or carrying forward restricted farm losses, the losses can only be claimed to a maximum of the net farming income in that year. Thus, restricted farm losses can only be claimed against net farming income earned.
In addition to being able to carry back or carry forward restricted farm losses, a portion of any losses not deducted by the farm while in operations can be applied against the capital gain when the land is sold. The restricted farm losses are added to the adjusted cost base (ACB) of the land when the capital gain is calculated. However, the amount of losses that can be added to the ACB is limited to the property taxes and mortgage interest in each year that the restricted farm losses were applied.
Inventory adjustments
One last wrinkle when determining farm losses is the impact of mandatory inventory adjustments.
A farmer must make an inventory adjustment when the following conditions are met at year-end:
- Income from the farming business is in a net loss position using the cash method, before any optional inventory adjustment, and
- Inventory purchased during the year (supplies or livestock) is still owned by the farmer at year-end.
In the case that both conditions exist at year-end, a mandatory inventory adjustment must be recorded as an increase in income. This adjustment is calculated as the lesser of:
- The loss before optional inventory
- The value of the purchased inventory at year-end
The value of the inventory at year-end is determined as the lesser of:
- The amount paid by the farmer for the inventory (cash cost)
- The fair market value of the inventory
Your Collins Barrow advisor can assist you in determining your eligibility to deduct losses and the amount of any restricted farm losses.
Laura Poland, CPA, CA, is a manager and Marcie Butler, CPA, CA, is a staff accountant in the Chatham office of Collins Barrow.