19 March 1998 External T.I. 9719605 - QUALIFIED FARM PROPERTY

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues:

1. Can the farm be considered "qualified farm property" under section 110.6(1) of the act at the date of death, if taxpayer elects out of 70(9)?

2. The taxpayer died intestate and it has taken two years to establish that the children will inheret the farm, on ultimate transfer of land from the estate to the children, is there a deemed disposition at FMV or would section 107(2) apply?

3. Does the property once transferred to the children qualify as "qualified farm property" under section 110.6(1) of the Act?

4. Because the taxpayer died intestate and it took over two years to determine the beneficiaries, is a trust created and does a T3 need to be filed during the period from date of death until ultimate transfer of the property to the children?

5. Is interest on funds borrowed to acquire other siblings portion of the property deductible?

Position:

1. It appears that the property will qualify as "qualified farm property".

2. Neither the FMV or section 107(2) would apply on the ultimate transfer of the land.

3. It appears that the property now owned by the children will continue to meet the requirements of 110.6(1)(vii) of the definition of “qualified farm property”

4. A trust was never established.

5. The interest appears to be deductible.

Reasons:

1. The property appears to meet the requirements of 110.6(1)(vii).

2. If the taxpayer elects out of subsection 70(9), the taxpayer will be deemed to have disposed of the property immediately before the death, at proceeds equal to the elected amount, and the children shall be deemed to have acquired the property immediately before the death at a cost equal to the proceeds. Subsection 107(2) would not be applicable, because the deeming provision in subsection 70(9) transfers the property directly to the children immediately before the death.

3. The property continues to meet the requirements of 110.6(1)(vii). The property acquired by the children in 1995 would qualify as "qualified farm property" under subparagraph 110.6(1)(a)(vi), if, in fact, in at least 2 years while the property was owned by a parent of the children, that is the father who died in 1972, the father was carrying on a farming business in Canada in which the individual was actively engaged on a regular and continuous basis and in which this property was principally used and if, in fact, the gross revenue from that farming business exceeded the father’s income from all other sources for the year.

4. Technically because of the election under 70(9) the income and expenses from the farming property should be allocated and reported on the children’s individual T1 returns, for the period from the date of death until the ultimate transfer of the property.

5. The interest expense should be deductible under 20(1)(c).

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All references in this letter which indicate that the children shall be deemed to have acquired the property “immediately before the death” should be read as the children shall be deemed to have acquired the property “at the time of the death”.

Please refer to document E971960A

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		5-971960
XXXXXXXXXX 	Karen Power, C.A.
(613) 957-8953

Attention: XXXXXXXXXX 

March 19, 1998

Dear Sirs:

We are writing in reply to your letter of July 7, 1997 in which you requested our views on five separate questions relating to the situation described in the following facts. We apologize for the delay in replying.

Facts:

1. The taxpayer died in 1995 owning a 100 acre piece of farm land. At the time of death, the farm was rented to an arm’s length farmer for a fixed sum of rent. The taxpayer did not live on the farm.

2. The taxpayer acquired the farm from her deceased spouse in 1972 when the spouse passed away. Prior to the spouse passing away, the farm was actively farmed in the family since the 1800’s.

3. Subsequent to the death of the spouse in 1972, the taxpayer lived on the farm until 1980 when she then moved away from the farm to live in the city, but rented the farm to an arm’s length tenant for a fixed sum of money on an annual basis ever since the date of the spouse’s death in 1972.

4. The taxpayer died intestate, and it has now been established that the assets of the taxpayer are to be left equally to the children of the taxpayer.

Our comments

The particular circumstances in your letter on which you have asked for our views appears to be a factual situation involving a specific taxpayer. As explained in Information Circular 70-6R3, it is not this Directorate’s practice to comment on proposed transactions involving specific taxpayers other than in the form of an advance income tax ruling. Should your situation involve a specific taxpayer and a completed transaction, you should submit all relevant facts and documentation to the appropriate district taxation office for their views. However, we are prepared to offer the following comments which may be of some assistance to you.

Question #1

Would the 100 acre farm be considered "qualified farm property" under section 110.6(1) of the Income Tax Act (the "Act") at the date of death, such that any gain in value of the farm since 1972 to date of death would be eligible for the lifetime capital gains exemption for qualified farm property of the taxpayer assuming the taxpayer’s estate elected out of section 70(9)?

One of the conditions that must be met for real property of an individual to be considered a "qualified farm property" within the meaning of subsection 110.6(1) of the Act, is that the property has been used in the course of carrying on the business of farming in Canada.

Whether a property is considered to have been used in the course of carrying on the business of farming is dependant on when the property was last acquired by the individual. In your situation, the taxpayer last acquired the farm land in 1972. Consequently, the farm land can be considered to have been used in the course of carrying on the business of farming if the requirements of either subparagraph 110.6(1)(a)(vi) or 110.6(1)(a)(vii) are met.

Real property may be considered to be used in the course of carrying on the business of farming in Canada if it has been owned, by the individual, a spouse, child or parent of such a person, a family farm partnership in which any of the above persons have an interest or a personal trust from which the person acquired the property, throughout the 24 months preceding the sale. In addition, it must meet either of the conditions described in clauses (a)(vi)(A) or (a)(vi)(B) of the definition of "qualified farm property" in subsection 110.6(1) of the Act.

Under clause (a)(vi)(A) of the definition of qualified farm property in subsection 110.6(1) of the Act, in at least 2 years while the property was owned by the individual, a spouse, child or parent of such a person, a family farm partnership in which any of the above persons have an interest or a personal trust from which the person acquired the property, the gross revenue from the farming business that is carried on by any of these individuals in which the property was principally used, and in which the individual is actively engaged on a regular and continuous basis, must have exceeded the individual’s income from all other sources for the year. In our opinion, the person meeting the gross revenue test need not be the person who owns the property and may be the parent of the individual or any other person described in subparagraphs (a)(i) to (iii) of the definition of "qualified farm property."

Alternatively, pursuant to clause (a)(vi)(B) of the definition of qualified farm property in subsection 110.6(1) of the Act, real property can also be considered to have been used in the course of carrying on the business of farming in Canada where the property was used by a corporation referred to in subparagraph (a)(iv) of the definition of "qualified farm property" in subsection 110.6(1) of the Act, or a partnership referred to in subparagraph (a)(v) of the definition of "qualified farm property" in subsection 110.6(1) of the Act, principally in the course of carrying on the business of farming in Canada throughout a period of at least 24 months during which time an individual referred to in any of subparagraphs (a)(i) to (a)(iii) of the definition of "qualified farm property" in subsection 110.6(1) was actively engaged on a regular and continuous basis in the farming business in which the property was used.

In addition, pursuant to subparagraph 110.6(1)(a)(vii) of the Act, real property acquired before June 18, 1987 or after June 18, 1987 under an agreement in writing entered into before that date, will be considered to have been used in the course of carrying on the business of farming in Canada and, therefore, qualify as "qualified farm property" provided the property was used by the individual, a spouse, child or parent of such a person, a family farm corporation in which any of the above persons own shares, a family farm partnership in which any of the above persons have an interest or a personal trust from which the person acquired the property, principally in the course of carrying on the business of farming in Canada, either in the year the property is disposed of, or in at least five years during which it was owned by the person, a spouse, child or parent of the person, a personal trust from which the person acquired the property or a family farm partnership.

The determination of whether real property is used principally by a taxpayer in carrying on a farming business is a question of fact. Where reference is made to an asset being used "principally" in the business of farming, the asset will meet this requirement if more than 50% of the asset’s use is in the business of farming. Furthermore, it is also a question of fact whether a particular farming operation constitutes a farming business at any particular time. Some of the criteria which should be considered in making this determination are set out in Interpretation Bulletin IT-322R. In addition, the Department’s general position with respect to the meaning of a farming business is outlined in paragraph 8 of Interpretation Bulletin IT-433R and paragraph 9 of Interpretation Bulletin IT-145R.

In your situation, the requirements of subparagraph 110.6(1)(a)(vii) appear to be met, if in fact, in at least 5 years during which the property was owned by the taxpayer (or her spouse), the property was used by the taxpayer (or her spouse) principally in the course of carrying on the business of farming. Since the requirements of subparagraph 110.6(1)(a)(vii) appear to have been met, in our view, the property will qualify as "qualified farm property".

Question #2

Upon the transfer of the land from the name of the taxpayer to the children as tenant-in-common, would there be a deemed disposition at fair market value subject to taxation in the estate’s hand, or would section 107(2) apply on the distribution of the farm to the children to settle their capital interest in the trust thereby deeming a "rollout" at adjusted cost base resulting in no capital gain to the estate of the children?

If, as mentioned in Question #1, the taxpayer’s legal representative elects out of subsection 70(9) of the Act, in the taxpayer’s return of income for the year in which the taxpayer died, paragraph (b) of subsection 70(9) shall be read as follows:

“(b) the taxpayer shall be deemed to have, immediately before the taxpayer’s death, disposed of the property and received proceeds of disposition therefor equal to such amount as the legal representative elects in the taxpayer’s return of income under this Part for the year in which the taxpayer died, not greater than the greater of nor less than the lesser of

(i) where the property was depreciable property of a prescribed class,

(A) its fair market value immediately before the death, and

(B) the lesser of the capital cost and the cost amount to the taxpayer of the property immediately before the death, and

(ii) where the property is land (other than land to which subparagraph (i) applies),

(A) its fair market value immediately before the death, and

(B) its adjusted cost base to the taxpayer immediately before the death,

and the child shall be deemed to have acquired the property at the time of the death at a cost equal to those proceeds, except that for the purpose of this paragraph, where the elected amount exceeds the greater of the amounts determined under clauses (i)(A) and (B) or (ii)(A) and (B), as the case may be, it shall be deemed to be equal to the greater thereof, and where the elected amount is less than the lesser of the amounts determined under clauses (i)(A) and (B) or (ii)(A) and (B), as the case may be, it shall be deemed to be equal to the lesser thereof, and".

Subsection 70(9) will only apply in circumstances, where the property is, as a consequence of death, transferred or distributed to a child of the taxpayer, within a period of 36 months. The election out of subsection 70(9) must be made in the taxpayer’s return of income for the year in which the taxpayers dies. Application to late file this election would have to be made under the fairness legislation and, as a result, as provided under subsection 220(3.2) the Minister may extend the time to make this election.

Thus, in your situation, if the taxpayer elects out of subsection 70(9), the taxpayer will be deemed to have disposed of the property immediately before the death, at proceeds equal to the elected amount, and the children shall be deemed to have acquired the property immediately before the death at a cost equal to the proceeds.

Subsection 107(2) would not be applicable, because the deeming provision in subsection 70(9) transfers the property directly to the children immediately before the death.

Question #3

If one or more of the children were to sell their interest in the farm at a future date, would the gain in value of the farm from the date of death of the taxpayer to the date of the sale of the child be eligible for the lifetime capital gains exemption as qualified farm property in the hands of the child? It is the intention of the children to continue renting the property to an arm’s length tenant for a fixed sum annually. They will not be actively farming the property on their own, nor living on the property.

Although the mother and children were never involved in the farming business, in our view, the property acquired by the children in 1995 would qualify as "qualified farm property" under subparagraph 110.6(1)(a)(vi), if, in fact, in at least 2 years while the property was owned by a parent of the children, that is the father who died in 1972, the father was carrying on a farming business in Canada in which the individual was actively engaged on a regular and continuous basis and in which this property was principally used and if, in fact, the gross revenue from that farming business exceeded the father’s income from all other sources for the year.

Question #4

Is there a trust created as a result of the delay in dealing with the property since the taxpayer’s death because of dying intestate? There has been rental income and expenses incurred with respect to the property since date of death. Presumable a T3 return should be filed covering the period from date of death until ultimate transfer of the property to the children.

Due to the implications of subsection 70(9), the property was deemed to be acquired by the children immediately before the death, and as such a trust was never established. As a result, the income and expenses from the farming property should be allocated and reported on the children’s individual T1 returns, for the period from the date of death until the ultimate transfer of the property. We understand, that this may be quite inconvenient as it may involve filing amended T1’s for each child for each year involved. In some situations, T3’s may have been filed before the election out of subsection 70(9) is made. You should contact your Taxation Centre to determine what method of reporting they would accept.

Question #5

There has been discussion of one or more of the children selling their proportion and interest in the property to the other children. If the other children were to borrow the funds to acquire the interest of the children wishing to dispose of their interest in the farm, would that interest be tax deductible to the other children from their proportionate share of the rental income from the farm?

Paragraph 20(1)(c) of the Act, provides for the deduction of interest, by a taxpayer in computing the taxpayer’s income, if the interest is paid in the year, pursuant to a legal obligation to pay interest on borrowed money used for the purpose of earning income from a business or property.

In order to properly determine the tax consequences relating to whether interest expense incurred by the children would be deductible, we would need to examine all the documents and agreements relating to the transaction. However, in our view, based on the facts provided, the interest in this situation should be deductible under paragraph 20(1)(c) of the Act.

We trust our comments will be of assistance to you.

Roberta Albert, C.A.

for Director
Business and Publications Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch

cc. Theresa Murphy
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