Machinery

Farm machinery is treated as a capital asset for income tax purposes. Machinery and equipment do not fall under the definition of “qualified farm property” for the purposes of the $750,000 capital gains exemption.

Tips and Traps

Capital Gains

• A disposition of machinery or equipment for proceeds greater than the original cost will result in a capital gain.
• The Income Tax Act does not include machinery and equipment as "qualifying farm property" for the purposes of the $750,000 capital gains election.

• In acquiring new farm machinery, farmers have increasingly been trading in a piece of machinery they own on a new piece of equipment that will be leased rather than purchased. The treatment of this type of transaction must be carefully reviewed.
• It appears as if at least two major forms of leasing agreements are prevalent. The first is a "capital lease," while the other is an "operating lease." A capital lease is frequently referred to as a "disguised" purchase agreement because the buyout is often less than fair market value.

Operating Lease
If an operating lease is chosen, then the trade-in of the old equipment should be shown as a disposition. It should also reflect a credit to the appropriate capital cost allowance class and recognize any capital gain. The value of the trade-in is likely a partial payment of lease payments, which should be deductible.

Prepaid Lease Payments
Be aware that legislation restricts the deduction of expenses (other than for inventory) for cash basis taxpayers where the expenses paid in the current period relate to a taxation year two or more years after the year of payment. In light of this, the trade-in value of the equipment may be partially deductible currently and partially in subsequent years if the lease term extends beyond one year after the year of the trade-in.
For example:
Facts: Traded in a tractor with a value of $90,000 on December 1, 2010.

• Value of trade-in is credited to the first 36 monthly lease payments of a 60-month lease (i.e. farmer will not need to make lease payments until month 37 on the new tractor).
• Lease payments on the new tractor would be $2,500 per month.
• First lease payment commenced December 1, 2010 (paid by way of credit for trade-in).

• An aggressive position would be to claim a tax deduction in 2010 for 24 months of lease payments (rather than 13 months as illustrated).
• Under the special "farm rollover" provisions, depreciable assets - depreciated under the declining balance method - can be transferred at the undepreciated capital cost of the assets. Recapture and/or capital gains are deferred until such time as the property is sold by the child. See the conditions to be met to allow this rollover as outlined in this book on capital cost allowance.
• Part XVII assets (pre- 72 assets depreciated under the straight-line method) can only be transferred at fair market value. No recapture will result, but it is possible that there could be a capital gain. Once the child acquires the property, capital cost allowance must be taken on the declining balance method.

• Declining balance assets transferred to a spouse during or after the lifetime of the farmer will generally move to the spouse at undepreciated capital cost. Any recapture of capital cost allowance or capital gain will be postponed until the sale of assets by the spouse or death of the spouse.
• Straight-line assets transferred to a spouse during a farmer's lifetime or on death will generally pass at "adjusted cost base." No capital gain, if any, will arise until the sale of the assets or the death of the spouse.
• Under the Income Tax Act, a farmer can elect to transfer depreciable assets to a spouse at the fair market value of the property. This provision would be useful where the spouse was going to continue to use depreciable assets in the active farm business and the deemed sale at fair market value would not result in significant tax to the farmer. (Note: the transfer must occur either at cost or at fair market value but not in between).

• Immediately before death, the taxpayer is deemed to have disposed of all depreciable property for proceeds equal to fair market value. Recaptured capital cost allowance as well as a capital gains may arise unless conditions in the will specify for a transfer to a spouse or child as described above.

• Where a farmer wishes to incorporate a farm business or transfer business assets to a partnership, assets such as machinery may be transferred to a corporation or a partnership without incurring an immediate tax cost. An individual may transfer machinery to either a corporation or a partnership at any amount between cost and fair market value if the appropriate income tax election is filed.
• An election form must be filed with the Canada Revenue Agency to record the transaction for tax purposes.
• Electing at any amount above cost will result in income to the transferor.
• To avoid tax, it is often necessary to elect on machinery at an amount equal to the undepreciated cost of the machinery. In some instances, this means that only debt up to the underpreciated cost can be transferred. Attempts to have more debt on the equipment transfer would result in an automatic increase in the elected amount and resulting tax. It may therefore be necessary to also transfer other farm assets that have cost base to allow debt to be assumed by the company without negative tax consequences.