Family Finance: No Need to Sell the Farm


Andrew Allentuck

In British Columbia, a couple we’ll call Glenda, who is 57, and Samuel, who is 60, are living a life others would envy. They have 24 acres of pasture surrounding their $750,000 house and rent out 53 acres worth an estimated $600,000 to a neighbour. They have total after-tax income of $4,964 per month, including Samuel’s $605-a-month Canada Pension Plan benefits. It’s more than enough money for living on the farm, but not enough for the retirement they would like. Like many Canadians exhausted with unrelenting winter, they crave a place in the sun.

Through hard work, discipline and perseverance, the couple has built a net worth of nearly $2-million. They want to experience what amounts to year-round summer. But parting with their roots will be emotionally challenging. “We have nostalgic connections with the farm,” Glenda explains. “The farm was in Samuel’s family. The rental property has been his for nearly a quarter of a century. These connections conflict with our financial picture. We can sell land for money or keep the land for tradition. But we do need to add to our cash flow to travel more and better.”

Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. of Kelowna, B.C., to work with the couple. “From a cash-flow perspective, the return on equity for the farm is approximately zero,” he says. “The couple’s needs have shifted from growing net worth to generating more income. They need to adjust their assets to meet their needs.”

“The choice facing the couple is to have the satisfaction of keeping all the land or selling the rental parcel and realizing other goals,” Mr. Moran says. “The 24-acre parcel and their farmhouse are not going to be sold. So the problem for the couple is how to reduce their workload and create reliable investment income.”

The Five Year Plan

Year 1 (2011) Sell the $600,000 parcel and use available RRSP room to offset high taxes in the year of the sale. Their cost was $110,000, so half of the capital gain of $490,000 would be taxable. The farm is not a principal source of income, nor was it held by the taxpayer prior to June 1987, two conditions that, if met, can exempt the gain from taxation. The capital gain will therefore be treated as ordinary appreciation. After an estimated tax bill of $80,000, there would be $520,000 to invest. That sum could produce $23,400 a year if invested to yield 4.5% a year in investment-grade corporate bonds. If they spend capital and allowed for 3% annual inflation, they could spend $25,040 until Glenda reaches 90.

Year 2 (2012) Family financial assets will have grown to more than $1-million. The couple should explore ways of managing their fortune, perhaps with the aid of a professional portfolio manager. If they choose to manage the money themselves, they should consider corporate bonds, stocks with growing dividends, and ETFs or mutual funds whose characteristics justify their fees. Year 3 (2013) Family income should be approaching six figures. It is time to start fulfilling travel wishes. They might buy or rent a property somewhere warm. If that’s the United States, it will be essential to obtain legal advice on exposure to U.S. succession duties and to have a lawyer put the U.S. property into a trust or corporate structure. If another country, they should check whether it has a tax treaty with Canada that affects withholding. 

Year 4 (2014) Income is due to rise when both Glenda and Samuel receive OAS benefits and when Glenda begins to receive her own CPP benefits. They should review U.S. rules on deemed residence, often called the significant presence test, and ensure, if necessary, that their testamentary plans are cognizant of U.S. state and federal tax laws pertaining to succession.

Year 5 (2015) Samuel is 65 and begins to receive Old Age Security. Family income will be about twice its starting level in year one. The financial plan for retirement is complete.

The Longer Term

By monetizing their land holdings, the couple will have been able to boost their income by as much as $25,040 a year. Now the job is to preserve and grow that  income. To do that, they need to have a balanced portfolio with both stocks and bonds. Sale of land and eventual accessions of CPP benefits by Glenda and OAS by both partners will produce a large boost in income. If their portfolio realizes 6% a year and inflation runs at 3% per year, then by 2019, when Glenda is 65, they should have as much as $102,250 in annual income, composed of Samuel’s $24,084 annual pension, two CPP benefits totalling $14,031 a year, two OAS payments of $12,514 a year in total and $51,620 from registered assets and from the land they sold. If they were to get 4% more than the 3% rate of inflation, their investments would yield $59,066 a year and would push their annual income up to $109,695 before tax. All figures are in 2011 dollars, the planner notes.

Shifting from land to financial assets with defined yields will make much of the couple’s income taxable. Money from sale of land will be outside of registered plans. They will need to do tax planning. A testamentary trust could be useful. The purpose of the trust would be continuity of ownership and income-splitting. The downside is a good deal of paperwork and professional expense, but it will be worth it, Mr. Moran says.

Glenda and Samuel also need to think about the disposition of their wealth after their lives. With no children and no family to whom they are close, they may wish to consider good causes — perhaps charities, educational institutions, religious foundations or hospitals — the list is long.

Many readers of Family Finance have expressed a concern that people with wealth be charitable. Those who choose to give should ensure themselves that the charity is efficient in its work. That means funds should go to the cause or projects intended. Many charities and non-profit organizations make their annual reports and other statements available online or by request. One may also check the Canada Revenue Agency charities website for insight into how the potential recipient of money handles its financial affairs. Not every good cause is a registered charity, but many are, and, as a benefit of compliance, registered charities can issue official tax receipts.

“Glenda and Samuel must decide about parting ways with some of their land,” Mr. Moran says. “If they sell the rental parcel, they could have income far greater than what they have now. They could be in a warmer place for a part of the year. It would be a life that they can have for many years of prosperous retirement. The plan shows how they can do it.”

(C) 2012 The Financial Post, Used by Permission