Taxes, Death and Woodlots: Avoiding the Capital Gains Tax Burden

Jamie Simpson

Not only are death and taxes life’s two notorious certainties, but they can be the source of perplexing questions for woodlot owners.  One thorny issue is whether capital gains tax must be paid when a child inherits or otherwise acquires a woodlot from a parent.

Children often feel compelled to clearcut an inherited woodlot to be able to pay the capital gains tax owing against their parent’s estate.  If the woodlot had increased in value by say, $50,000, then the estate could be responsible for more than $8,000 of income tax depending on the parent’s marginal income tax rate.

Now, fortunately, the Income Tax Act and the Canadian Revenue Agency’s (CRA) interpretation of the Act allow children to avoid the tax, either when inheriting or otherwise acquiring the property, provided that the woodlot activities can be considered to be both farming and commercial in nature.

Please note that this article is provided for general information purposes only, and is not legal advice.  A woodlot owner should consult with her or his lawyer and accountant for detailed advice about her or his specific circumstances.

When is your Woodlot a Farm?

The first question is whether the woodlot is a farm.  “Of course it’s not a farm!” many woodland owners would sensibly answer.  However, the Canadian Revenue Agency provides some favourable tax advantages for lands that are considered to be farms, and the Agency has decided (thanks to some serious lobbying effort by woodlot organizations) that certain woodlot operations can be described as farming operations (at least for the purpose of the tax benefits).

We once looked to the Income Tax Bulletins for advice on how the CRA interprets various sections of Income Tax Act.  However, not resting on their laurels, the CRA is gradually replacing the Income Tax Bulletins with Income Tax Folios.  What’s a ‘folio’?  I don’t know.  Income Tax Bulletin IT-373R2 used to be our go-to source to determine whether a woodlot is a commercial farming operation.  Now, sections of this Tax Bulletin have been replaced by Tax Folio 11 (Meaning of Farming and Farming Business).  None of this is particularly useful for most woodland owners, and I include only as an example of why some lawyers are driven to drink.

In any event, pulling together the relevant sections of Folios and Bulletins, we know that the CRA considers a woodlot operation to be ‘farming’ in nature if the focus of the operation is planting, nurturing, and harvesting trees according to a forest management plan, or, in other words, where the owner manages the growth, health, quality and make-up of the woodlot.  If, however, the focus of the woodlot operation is simply producing timber without much thought to long-term management and care of the woodlot, then the operation is considered a logging operation.  Even where a landowner replants areas with trees, if the focus is limited to timber production, then it is logging and not farming, at least in the eyes of the CRA.

In my interpretation, those woodlot owners who thin to promote the growth of favourable species, release crop trees to focus growth on desirable trees, and/or harvest in a way to encourage favoured species to seed and grow, all according to a forest management plan, can consider their woodlot operations as farming for the purposes of the Act.

When is your Woodlot a Business?

The second question to answer is whether the woodlot operation (which we will consider to be farming) is also a business (that is, a commercial woodlot).  Again looking to the appropriate Tax Folio and Bulletin, we know that the CRA looks to a number of factors to determine whether the woodlot is a commercial operation.  These include whether the woodlot owner has a management plan in place and is following it, whether the owner has (or has hired) expertise necessary to implement the management plan, and whether there’s a reasonable expectation of profit.  For the latter factor, where there is very little or no gross income for several years, the presumption is that the woodlot is not a commercial operation.  However, the CRA also recognizes that revenue in woodlot operations can be highly periodic.  Ultimately, a pattern of losses and marginal revenue can indicate that the operation is a hobby woodlot rather than a commercial business.  Such woodlot owners who claim otherwise tend to be the ones who end up in court.  Membership in an association of woodlot owners may also point towards a commercial operation.

What’s the Benefit of a Woodlot Farming Business?

If you are nurturing the growth of your woodlot according to a forest management plan, and can show some viable commercial activity, then you likely have a commercial farm woodlot.  If so, then you can pass the property on to your children, either while you are alive or in your will, without the burden of accruing capital gains tax during the transfer.

 

A Forest Management Plan, According to the Income Tax Act

Section 7400(1) of the Income Tax Act defines a forest management plan as a written plan that

• Describes the composition of the woodlot, provides for the attention necessary for the growth, health and quality of the trees on the woodlot, and is approved in accordance with the requirements of a provincial program established for the sustainable management and conservation of forests; OR
• Has been certified in writing by a recognized forestry professional to be a plan that described the composition of the woodlot, provides for the attention necessary for the growth, health and quality of the trees on the woodlot and includes
  1. A description of, or a map indicating, the location of the woodlot,
  2. A description of the characteristics of the woodlot, including a map of the woodlot site that shows those characteristics,
  3. A description of the development of the woodlot, including the activities carried out on the woodlot, since the taxpayer acquired it,
  4. Information acceptable to the recognized forestry professional estimating
     1. The ages and heights of the trees on the woodlot, and their species,
     2. The quantity of wood on the woodlot,

• The quality and composition of the soil underlying the woodlot, and

1. The quantity of wood that the woodlot could yield as a result of the implementation of the plan,

1. A description of, and the timing for, the activities proposed to be carried out on the woodlot under the plan, including any of those activities that deal with
   1. Harvesting
   2. Renewal and regeneration

• The application of silviculture techniques, and

1. Responsible stewardship and the protection of the environment, and

1. A description of the objectives and strategies for the management and development of the woodlot over a period of at least five years.

A recognized forestry professional is someone with a degree, diploma or certificate recognized by the Canadian Forestry accreditation Board, the Canadian Institute of Forestry, or the Canadian Council of Technicians and Technologists.