Foreclosure and repossessions
Section 79 of the Income Tax Act applies whenever a farmer surrenders property and a creditor acquires or reacquires the beneficial ownership of a farmer's property due to failure to pay all or any part of a debt. The debt not paid may be principal or principal plus interest. An acquisition or reacquisition of property may take place by means of:

a foreclosure order obtained through a court
repossession or seizure
a quit claim

Even though the property is taken from a farmer through foreclosure or seizure, the farmer is deemed to have sold it. This can also happen when a farmer gives property to a creditor in exchange for a quit claim when payments have been missed.

When a creditor acquires or reacquires property from a farmer, the farmer is deemed to have received proceeds of disposition which include the amount of principal and interest owing immediately before the property is surrendered to the creditor. The exact amount of the deemed proceeds of disposition is determined in accordance with a formula specified in subsection 79(3) of the Income Tax Act. It also includes any debt owing to other creditors that is extinguished as a result of the surrender of the property. This deemed sale could therefore result in a capital gain, recapture of depreciation or even taxable income. If for any reason a farmer has to pay the creditor after the property has been acquired or reacquired by the creditor, the amount paid is deemed to be a loss for the farmer. This loss will be a capital loss if the property was land. These capital losses can be applied against any resulting capital gain caused by the deemed sale of the reacquired property or carried forward and applied against future capital gains.

Technically, if a farmer has not failed to pay all or any part of a debt but property was acquired or reacquired due to a default under other terms of the loan, section 79 may not apply. It may only apply when there is a default in payment. Therefore, other income tax provisions would be applicable. As this is a technical point, professional legal advice should be sought when property is acquired or reacquired by a creditor without the farmer being in arrears on a loan.

Because section 79 only applies when the creditor acquires or reacquires property, it will not apply when a foreclosure or seizure results in the property being sold to a party other than the creditor. Also, if a creditor sells its debt and the purchaser of the debt acquires the property from the farmer, section 79 may not apply since it would not be the creditor who is acquiring the property.

In most farm property repossession cases, section 79 will not result in a tax liability. As a simplified example of this, assume the following:

A farmer purchased land in 1997 for $500,000 and financed the full amount with a bank loan secured by a mortgage on the land. The farmer had no other debt on the property.
No interest was charged (for simplicity's sake).
The first year payment of $50,000 was made, but the farmer was unable to make the second year payment in 1998.
The bank acquired the land in 1998 through foreclosure proceedings which satisfied the unpaid balance of $450,000.

The farmer would be deemed to have disposed of the land in 1998 with the following results:

Farm Debt: Income Tax And G.S.T. Consequences

Deemed proceeds of disposition	$450,000.00 [From formula in 79(3)]
Less: Adjusted Cost Base (cost of purchase in 1997)	-$500,000.00
Capital Loss	($50,000.00)

In most cases where the value of the property has declined below the original purchase price, there will be no tax because the tax cost will be greater than the deemed disposal proceeds.

However, in those cases where a creditor acquires or reacquires property with a tax cost below the deemed proceeds of disposition, a tax liability can occur. For instance assume that in 1997 the farmer had mortgaged land that he had owned for a number of years for the purpose of acquiring a $500,000 loan and this land was worth $50,000 on December 31, 1971 (Valuation Day for capital gains purposes). Also assume that this land was acquired by the lender in 1998 on a foreclosure. The farmer had no other debts on the land. The farmer's 1998 taxable position would be as follows:

Deemed proceeds of disposition	$450,000.00 [From formula in 79(3)]
Less: Adjusted Cost Base (Valuation Day Value)	-$50,000.00
Capital Gain	Capital Gain

In such situations, the farmer could possibly use the "once-in-a-lifetime" $500,000 capital gains exemption for qualified farm property to negate the tax liability created by the resulting capital gain. Although the $500,000 capital gains exemption could be used to alleviate the tax liability in the above example, situations exist where seizure or foreclosure of depreciable property (buildings, machinery) will result in a recapture of depreciation which is not a capital gain and thus not offset by the $500,0000 capital gains exemption. Furthermore, the $500,000 capital gains exemption is not necessarily available for all tax payers because certain requirements must be met to qualify for the exemption.

A farmer will have no tax liability under the Alternative Minimum Tax system in situations where property is acquired or reacquired and section 79 of the Income Tax Act applies. However, a farmer potentially could have to pay alternative minimum tax when property is acquired or reacquired and section 79 does not apply. This tax would be payable despite the existence of the $500,000 capital gains exemption. There is also no alternative minimum tax payable by a farmer when he or she declares bankruptcy.

In cases where the acquired or reacquired property did not satisfy the debt in full and the farmer had to render a cash payment to the creditor, this cash settlement would be treated as a capital loss. If, in the example above, a farmer had to make a $100,000 cash payment to a creditor, the resulting $100,000 loss could be applied against the $400,000 of capital gain, thus retaining more of the $500,000 capital gains exemption for future use.

With respect to the Goods and Services Tax, when a farmer's property is seized or repossessed by a creditor as satisfaction in whole or in part for a debt or obligation owing by the farmer to the creditor, the transaction is deemed to have taken place for no consideration, thus no G.S.T.

Settlement of debts
Section 80 of the Income Tax Act applies when a farmer's commercial debt is settled or extinguished after partial payment or non-payment. Debt is usually settled or extinguished when a creditor actively forgives or releases a farmer from paying the debt or when the creditor can no longer legally collect the debt (because of time limitations). A commercial debt obligation is generally a debt where, if interest was paid or payable or if it had been paid or payable, the interest would have been deductible. The amount of the forgiven debt affected by section 80 is determined by a formula specified in the Income Tax Act and includes interest obligations forgiven. Section 80 can apply when a parent forgives a debt owed by a child without taking back property. (Note: In most cases, if section 79 applies then section 80 cannot apply to the same debt.) The application of section 79 is more common in a farm debt situation because most creditors settle these debts by acquiring or reacquiring a farmer's property through foreclosure, seizure or quit claims.

Section 80.01 of the Income Tax Act deems that when a debt to an unrelated creditor is no longer collectable by that creditor because of the expiration of the limitation period, the debt is deemed to have been settled or forgiven at that time and the provisions of section 80 apply. If a farmer makes a subsequent payment to this creditor with respect to this same debt, the farmer will be allowed to deduct a portion of this from income of the year the payment was made.

Section 80 does not apply when a debt is forgiven in a will. This is an important estate planning consideration when contemplating sales of property between a parent and a child. Section 80 also does not apply to forgiven debt the amounts of which were originally:

otherwise included in the debtors income under the Income Tax Act;
deducted in computing any balance of un-deducted outlays, expenses or other amounts; or
deducted in computing the capital cost or cost amount of any of the farmer's property.

Furthermore, section 80 does not apply to a forgiven debt which is an unpaid expenditure of a farmer who files income tax on the cash basis.

When section 80 applies to the forgiveness of a debt, the section provides that the amount of forgiven debt must, or in some cases, may be used to reduce certain losses that could be brought forward from previous years (including farm and capital losses), capital cost amounts and the un-depreciated capital cost of depreciable properties, adjusted cost base amount of land and other capital properties, current year capital losses, etc. in a specific order specified in the section. The application of the forgiven debt to reduce some of these tax attributes is mandatory while the application of the forgiven debt to reduce other listed tax attributes is optional.

If a farmer has previous non-capital losses and farm losses that could be brought forward to reduce the farmer's current year's income, any unforgiven amount of debt in the current year must first be used to reduce these losses. Due to certain time constraints, a farmer can lose the right to use such losses from previous years to offset income. Therefore, the application of section 80 to reduce or eliminate past losses which would otherwise expire can be beneficial to a farmer in certain circumstances.

If a portion of the forgiven amount of the debt is used to reduce the tax cost of depreciable property or capital property owned by the farmer at the time the debt is extinguished and such property is later disposed of, these adjustments may result in an increased amount of recapture of depreciation or capital gain with a greater amount of tax payable by the farmer.

If there is still an amount of forgiven debt remaining after all these specific reductions or adjustments have been made, three quarters of this remaining amount of forgiven debt may be included in the farmers income for that year and taxed accordingly. However, if the forgiven debt was owned by a farm partnership, all of the remaining forgiven debt would be included in the partnership's income unless the partners chose to deduct their proportionate shares of the income in which case the forgiven debt would be treated as if it was the partners' forgiven debt. Instead of including the remaining balance of forgiven debt into a farmer's income, the farmer can elect to transfer this amount to a related corporation or partnership, which could then apply this amount of forgiven debt to reduce its tax attributes in the same manner set out in section 80.

Conclusion
The tax rules associated with resolving farm debt situations are confusing. Fortunately, it is not common for farmers to have tax problems in these situations. Before taking any steps to deal with a debt problem, a farmer should consult a knowledgeable tax specialist. The specialist can advise a farmer whether or not there will be a tax problem and what steps should be taken to minimize any tax liability.
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This information published to the web on March 11, 2002.