When woodlot owners die, their families can be faced with a major income tax burden, Those who care about their forest land, and their families, should do some planning before inheritances becomes an immediate concern.
In income tax terms, you are deemed to have 'disposed of' all your property when you die. The 'proceeds of disposition'. Which are equal to the fair market value of the property at the date of death, must be accounted for in the calculation on income taxes. If property passes to your spouse, the problem is deferred, but not solved. Taxes become a critical issue when the woodlot passes to a child or grandchild.
Here's how it works. Your 'cost', or 'adjusted cost base' (ACB), is essentially what you paid for the property. If you inherited the woodlot, then the ACB is the fair market value as of the date that you inherited it. There can be additions and deductions to the ACB; the most common addition would be for property taxes or interest, which were not claimed as expenses for tax purposes.
To determine if there is a capital gain when you dispose of a property, or when you are deemed to dispose of the property, your adjusted cost base is subtracted from the proceeds of disposition. Any costs of disposition, such as legal fees, are also subtracted. The result is your capital gain or loss. If you have owned the property for some time, a gain is much more likely then a loss.
The taxable capital gain is ¾ of the total. This amount is added to your income. The amount of tax you will have to pay depends on your marginal tax rate, which can vary from about 27% to in excess of 50%. When a taxpayer dies, these computations are done in the deceased person's final tax return.
If you actually sell the property, this is not so bad. At least you have cash from the sale to pay taxes. But in the case of a deemed deposition, such as the one that occurs at death, there is no cash from a sale with which to pay taxes. This presents a problem.
Bad Policy
In some cases of inheritance there may be cash from other sources available to pay the taxes- either from savings or investments, or from the proceeds of life insurance. Sometimes, however, the only source of cash is the woodlot itself. This can lead an heir to clear-cut inherited property, perhaps at an inappropriate time. In many cases, the need for cash overrides good forestry practice.
In this situation, income tax policy can encourage poor forestry practices. Woodlot owner organizations have been working for more than a decade to bring about changes in the tax laws which would, if not promote good forestry practices, at least stop encouraging bad ones. It has been a slow process, but both the Department of Finance and the Department of National Revenue now appear to see and understand the problem. Along with the woodlot owner organizations, they are looking for solutions will probably involve legislative change, and that in itself can be a slow process. In the mean time, what can the woodlot owner do.
If you were thinking that you can solve the problem by just giving the woodlot to your children now, forget it. If you give the property to someone you are related to, or sell it to them for less then fair market value, then you will have deemed proceeds of disposition equal to fair market value. Take a look at what this will do to you capital gain, as discussed above.
Revenue Canada views a managed woodlot farm, and there is a rollover, a tax-deferred transfer, a farm property available under Section 73 of the Income Tax Act. But this requires that the property be 'actively' farmed, and on most woodlots that level of activity, i.e. silviculture and harvesting, is so sporadic that it is unlikely the property would qualify, though some may. The woodlot may also be 'qualified farm property', and therefore eligible for the capital gains deductions. Again, this requires a certain amount of activity and, in some cases, a minimum amount of revenue generated over time.
Starting a Business
If you can demonstrate that the woodlot is a business - and this can be done - then another alternative would be to transfer the woodlot to a corporation. The shares of the corporation would be considered 'qualified small business corporation share', and would be eligible for the capital gains deduction. This can be an expensive solution, since the corporation will have to prepare financial statements and file a tax return annually, but it could be worth it for a large holding of land where the gain can be significant.
The best approach is to think through a long-term plan, and get your family involved in the ownership of the woodlot at an early stage. If the woodlot has only appreciated in value by a small amount, the tax cost of transferring ownership may be very small compared to what the savings could be in the future.
Corporations, partnerships and trusts are all vehicles that could be used to transfer the growth in a woodlots value to your family, while allow you to maintain some control over the department of the woodlot.
The key, as in all aspects of good woodlot management, is planning. This best time to start is when you do your initial management plan. The next best time is now.
Bruce Lunergan is a chartered account and certified management accountant in Fredericton, New Brunswick. This article has been reprinted for the Atlantic Forest Review - Volume 6 (January 2000 edition). Published by DvL Publishing Inc., Box 1059, Liverpool, Nova Scotia, B0T 1K0
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