A career in farming is marked by an abundance of loss. Loss of animals, loss of crops, loss of property, and loss of income. There are typically only a few days of the year when farmers and ranchers get paid, and there will be years in which producers ultimately lose money from their operations. High costs of production, fluctuating commodity yields and market prices, and economic and geopolitical factors can lead to highly volatile farm income and result in farm cash losses. The farm loss rules under the Income Tax Act (Canada) can further disadvantage a lot of farmers, but with careful tax planning within the scope of a farm's broader succession planning objectives, these rules can also provide significant tax relief. A recent decision from the Tax Court of Canada clarifies the application of these rules for farmers who rely on off-farm income to fund their operations, which is a good portion of Canadian farmers.
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Introduction to Farm Losses: Farmer Classification
Farm losses generally occur in any given year where the expenses incurred in operating a farming business exceed the income it generates. These losses can be used as part of a tax strategy that claims losses against net income to reduce the producer's taxable income, thereby lowering the amount of payable tax. The treatment of farm losses is governed by specific rules in the Income Tax Act (Canada) and depends largely on whether the farming activity is the farmer's main source of income.
The Supreme Court of Canada recognizes three classes of farmers that are used in the farm loss analysis. For the sake of simplicity, "farming" refers to farming, ranching, and beekeeping, and "farmer" refers to farmers, ranchers, and beekeepers. The three classes of farmers for taxation purposes are:
- Farmers whose livelihood is farming and who reasonably expect farming to provide most of their income ("Full-Time Farmers");
- Farmers who carry on farming as a side business with a reasonable expectation of profit, but do not look to farming for their livelihood ("Part-Time Farmers"); and
- Farmers who carry on farming activities as a hobby, do not look to farming for their livelihood, and have no real expectation of profit ("Hobby Farmers").
Each of these classes receive different tax treatment with respect to farm losses. This article focuses on Full-Time Farmers and Part-Time Farmers since Hobby Farmers cannot deduct their farm losses.
Reliance on Off-Farm Income
According to census data from Statistics Canada, as of 2021, off-farm income (off-farm wages/salaries, investment income, pensions, etc.) accounted for a little over half of the total income for farm families across Canada. Off-farm employment income specifically accounted for about 64% of that total off-farm income. When considered in light of the economic realities of agricultural production today, these statistics suggest that in some cases it can be virtually impossible to successfully operate a farm without off-farm income. While the legislative scheme governing farm losses limits immediate tax deductions by Part-Time Farmers, there may be other ways for producers to take advantage of these tax rules to put themselves and their families in a better position to carry out their farm succession goals.
Fully Deductible Farm Losses
Under the current regime, Full-Time Farmers can carry back their net farm losses up to three years or forward up to 20 years. If farming is the farmer's main source of income, there are no restrictions on the amount of farm losses that can be applied and deducted. This means that Full-Time Farmers can deduct the full amount of their farm loss from other sources of income in any year three years prior to the year of loss or any year within the following 20, depending on what will be the most advantageous. For example:
George is a row crop farmer near Taber, Alberta who earns most of his income from farming and is classified as a Full-Time Farmer. In 2024, George incurred a total farm loss of $50,000. Because this loss is fully deductible, under the farm loss rules, George can carry the loss back to offset income from 2021, 2022, or 2023. Alternatively, George can carry the loss forward to offset income in any year up to 2044. In whatever year the loss is applied, George's income from that year will be reduced by $50,000 to lower his income tax liability.
Restricted Farm Losses
The rules governing restricted farm losses for Part-Time Farmers are more complicated and, unfortunately, these are the rules affecting the most producers. The current provisions restrict farm loss deductions for Part-Time Farmers (farmers whose chief source of income is neither farming nor a combination of farming and some subordinate source of income). Part-Time Farmers can only deduct up to $17,500 against net farming income in one of the three prior years or in one of the following 20 years. It should be noted that the amount can only be deducted against net farming income in the year the farmer chooses to apply the loss.
The specific breakdown of this rule is as follows. Losses incurred by Part-Time Farmers are limited to the lesser of:
- the full amount of the farm loss for the year;
- $2,500 plus one-half of any loss in excess of $2,500; or
- the maximum total loss deduction limit of $17,500.
For example:
Tammy is an accountant but also raises cattle near Rimbey, Alberta. Tammy's accounting job provides her main source of income and she incurs a net loss from farming of $10,000 in 2024. The amount she could deduct in the carryback or carry forward years would be limited to $6,250 applied against only farming income in the year the deduction is used.
Farm corporations are subject to the same farm loss rules that apply to individual farmers; the key difference is that farm corporations are not labelled in the same way (Full-Time Farmer, Part-Time Farmer, etc.) and the main concern is whether the farm corporation's chief source of income is farming. As such, it may be beneficial to structure your farming business as a farm corporation or another entity type, so seek professional guidance in your circumstances.
Succession + Estate Planning Considerations
Farm losses can be applied strategically to reduce tax liabilities that might arise when transitioning the farm to a successor, especially considering the carryback or forward flexibility. For example, a family might look to transfer farm assets at such a time that losses can be utilized most effectively. It should be noted, however, that for intergenerational succession planning, losses cannot be used by the farm's successor(s) to offset future income. Although this would mitigate potential sources of financial hardship during a critical period in the farm's transition, farm losses are personal to the taxpayer who incurred them, so they cannot be transferred to a successor. Nevertheless, this may still be an important timing and strategic consideration.
As noted above, the farm loss rules also apply to farm corporations which may be relevant with respect to succession planning. For example, if a farming operation is run through a corporation and the farm corporation incurs a cash loss, the corporation will still be able to apply that loss in any of the carryback or forward years, even if the farm corporation has transitioned to new ownership. This is because a corporation is legally considered to be a separate "person" and the farm loss remains "personal" to the corporation.
In the estate administration context, farm losses can be used to reduce the taxable income of an estate when they are applied to the testator's terminal year tax return. Fully deductible farm losses can be combined with other deductions, such as the capital cost allowance, and executors can adjust deductions to optimize the use of restricted farm losses to more effectively manage and reduce taxable income. Furthermore, farm losses can be used in other tax planning strategies involving farm inventory adjustments, which is why it is so important to hire the right professionals to explore ways of improving your tax position.
Stackhouse v. The King, 2023 TCC 156: A Case Study
Reviewing some case law can help explain and illustrate the restricted farm loss rules in application.
The interpretation and application of the restricted farm loss rules were clarified in the Tax Court of Canada's 2023 decision, Stackhouse v. The King. The appellant was a medical doctor from New Brunswick who purchased farmland to start a cattle operation in conjunction with her medical practice. The appellant worked approximately 1,800 to 1,900 hours per year as a physician, while she spent approximately 2,500 hours per year farming. The appellant claimed farm losses on her income tax returns every year since 1987 with the exception of 1993 and 1994, but the CRA's reassessment looked specifically at 2014 and 2015 (the "Reassessment Period"). During the Reassessment Period, the appellant earned a net income of about $672,000 on average per year as a doctor and generated about $208,000 in gross revenue from farming while incurring losses of approximately $563,000 on average per year in her farming business. The appellant's income from farming was obviously significantly less than her employment income as a medical doctor.
In its analysis, the Court examined the meaning of "chief source of income" and "subordinate source of income" from the Income Tax Act (Canada) to ascertain Parliament's intention behind the relevant provisions. Parliament clarified, by way of a technical note, that this formulation was to ensure that taxpayers whose main occupation is not farming would be limited in their ability to deduct farm losses. It is unlikely that the drafters realized how many farmers across Canada must rely on off-farm income to keep their operations running and would accordingly be classified as Part-Time Farmers.
The Court reviewed relevant case law and determined that the characterization of a farmer's source of income is fact-specific and depends on the circumstances. The chief source of income is simply the main source of income that a taxpayer looks to for his or her livelihood. For purposes of the restricted farm loss rules, a farming income can exist alongside other sources of income, but in order to utilize the deduction, any other source of income must be supplemental, subordinate, or secondary to the farming income.
As applied to Dr. Stackhouse's appeal, the Court determined that she ultimately expected to increase revenue from farming but achieving that end would require significant expenditures. Additionally, there was no objective evidence that farming would become a self-sustaining business for the appellant in the foreseeable future despite her best efforts to do so. In addition to generating significantly more income, the appellant's medical practice was the centre of her work routine, as her activity on the farm only ever took place before and after her full-time medical job and she would often leave the farm to answer emergency calls. Indeed, the farm was funded by income from the appellant's medical practice, and the farm would not have been able to survive without that funding.
For those reasons, the Court held that in the Reassessment Period, the appellant's medical practice was her chief source of income and farming was a subordinate source. Thus, the appellant's loss from farming for each of the years in the Reassessment Period was limited to $17,500. In its conclusion, the Court opined that the current regime precludes producers with bona fide farming businesses from deducting losses that would be available to other kinds of business owners. The Court also interestingly remarked that this outcome was unfortunate and likely unfair. It stated that, since the Tax Court of Canada is not a court of equity, the law must be applied as written without regard to fairness.
Many producers and agricultural organizations became aware of this case and its outcome, which led to calls for legislative reform since the regime as it stands essentially punishes Part-Time Farmers who rely on off-farm income to run their operations. In many cases, it limits a farmer's deductible cash losses to a mere fraction of the losses the operation actually incurred through legitimate business endeavours. The restricted farm loss rules could disincentivize people from using off-farm employment to fund their farming businesses, which is very common in Alberta, and in some cases is the only viable way for these farms to survive. This is particularly true for first-generation producers looking to get started in the industry. Despite these limitations, if producers can strategically use the farm loss rules to deduct farm losses, they can achieve broader farm succession objectives.
Conclusion + Takeaways
The strategic use of farm loss rules can provide significant tax relief to producers, especially when preparing to transition the operation to the next generation. Although the farm loss rules may seem overly restrictive in many cases, they can still be beneficial if applied correctly. They can be strategically leveraged in your succession planning efforts to minimize tax liability as you look to transfer farm ownership. Using cash losses from down years to improve your tax position and the financial viability of your farm is a worthwhile endeavour. This is especially true considering the challenges producers face in today's economic and political climate, where new and uncertain threats continue to arise, presenting additional obstacles in achieving farm continuity.
Contact Aidan Nicholson or any member of Field Law's Agriculture Group for assistance with agricultural succession planning, farm-related estate administration, or structuring your farming business.