Katherine Cox* was land-rich from birth. She inherited large tracts of land from her mother in 1970. Her father, who had amassed the parcels, died just before she was born in 1941.
The Lloydminster, Alta. native was the only child of an early territorial settler who obtained the land prior to the turn of the 20th century. These settlers originally filed for homesteads of 160 acres, which they had three years to improve. At that point, they were able to purchase it for a fee of $10. Successful farmers gradually bought neighbouring acres and built their farmland.
While some of the best parcels were sold a generation ago, Katherine still holds title to hundreds of acres, as well as the mineral titles to the lands.
Two parcels, which total 250 acres, contain evidence of First Nations burials and may have archeological value. Katherine would like to bequeath those to either a heritage or conservation organization. Three quarters of that land is in Saskatchewan; an additional 450 acres are in Alberta.
The remaining 800 acres are pasture lands located along the Battle River, south of Lloydminster, on both sides of the border. The majority of this land is in Alberta, but about 30% is over the Saskatchewan provincial line. The parcels have not been formally appraised since the late 1960s. That valuation came in at $650,000, but farmland in the region is currently fetching $1,300 an acre in areas with no development potential. The developable properties, and those with resource extraction potential, are Katherine’s economic wildcards.
The 73-year-old recently got bad health news—a cancer diagnosis that comes with a three-year life expectancy. Her husband died 10 years prior in an industrial accident. Katherine lives a comfortable, modest lifestyle on the proceeds of an annuity purchased with funds from a wrongful death settlement paid by his employer. She has no other income outside of CPP/OAS, and has no RRSP or unregistered securities accounts. She lives in the house her father left her in Lloydminster, Alta., and keeps a consistent, combined balance of $46,000 in her savings and chequing accounts.
She has two daughters and one son, ages 55, 47 and 36, respectively. All have their own careers and none depend economically on their mother.
Katherine’s acutely aware that her major bequeaths will be in land and wants to ensure tax penalties to her heirs are minimized. And, if possible, she wants to harvest some benefits from charitable land contributions made within her will. She has no idea how to structure those donations.
Valuing the land
VM: The first issue I would look at is valuation. To do that, I’d look at prices of lands with similar characteristics and locations. I would also identify the stakeholders, and that starts with asking who actually owns Katherine’s property. So many times, I’ve pulled the titles of properties like hers and found registered interests the owner had forgotten about or was unaware of. For instance, there can be separate titles for the surface parcel and any minerals the land contains. There would also be separate valuations for each.
When looking at rural properties, I go out and actually stand on the land and examine the location, assess access to the property, find out who’s using the property and for what, and assess what it could potentially be used for.
The valuation for pasture lands would be about 60% of cultivated land, and the Alberta valuation would be higher than the Saskatchewan. That has nothing to do with the fact that, historically, the value of agricultural lands is based on productivity. We’re seeing across North America that prices have almost nothing to do with productivity.
If Katherine wanted to sell, I would advise her to put it through a tendering process. This involves providing a full description of the land to prospective buyers, and then giving them a set period of time to enter sealed bids. Typically, they ask me about price expectations; my response is they should offer what it’s worth to them. You typically get interest from neighbouring landowners who want to expand their farms, and investors who want long-term stability for their portfolios.
Since there’s evidence of aboriginal burials, I would approach the local First Nations. Often, they will make strong offers to gain control of the land.
AS: Katherine may consider donating it. When you make a gift of land to a government or public authority, which can include First Nations, or a registered charity that’s focused on environmental preservation, not only are there no capital gains, but you also get a tax credit. In Katherine’s situation, that credit could go a long way toward offsetting capital gains if she sells any of the farmland.
AS: The resource property—her wild card—is currently undeveloped.
VM: We have lands in this area where 300 acres produce a million dollars a year in royalties to the owner.
AS: If there’s no exploration, she probably still has to get a professional appraisal to determine the likelihood of there being minerals. If they find oil or gas during her lifetime, she’s got a Canadian resource property, and that could hit much harder on the tax front than capital gains if she doesn’t plan properly. That’s because minerals are taxed as income.
KS: There are definitely tax planning issues. She may try to ignore the fact that there could be minerals, but CRA gets the list of her assets for probate, so they would be aware she held mineral-rich lands on the date of death. If a valuation isn’t done on the minerals, there’s significant exposure to the estate because CRA could come in and impute their own value. The message to Katherine is, “We realize the minerals aren’t producing, but that doesn’t mean there isn’t any value under the ground.”
That can get contentious. The client often comes back to us and says, ‘No, they’re not worth anything. How could CRA deem them worth something when we’re not producing?’ The comment I often make to create some awareness of the value is, ‘Well, what would you sell to a third party for?’
My recommendation is to have a valuation done by an independent third party. Typically, they measure the reserves under the ground, compute a cost to extract it and factor in the current value of oil. We’ve had CRA audits on the value of minerals and have had no problems because we had an independent third-party valuation.
As Al notes, the value of minerals is straight income on a tax return. If CRA says it’s worth $100 million, that means $100 million of income. Worst-case scenario: she bankrupts the estate because she can’t find a buyer for the minerals and is left with a large imputed value.
But she can cut the tax in half with proper planning. First step is to transfer the mineral rights into a corporation at the appraised value. That value’s still taxable, but as a capital gain instead of income. Another issue is whom Katherine makes shareholders. They can be whomever she wants, including herself. If she issues them to herself, a valuation is done again in her estate, which then pays capital gains. Given the fact pattern, it would probably make sense for Katherine to issue the shares only to the beneficiaries of her estate—the adult children.
There’s another way to structure it. Katherine could issue the shares to a discretionary family trust. She would be a trustee, and at her discretion she could pay dividends to the beneficiaries, including herself. On her death, the shares held by the trust would not form part of her estate for probate purposes.
AS: There are steps Katherine can take to dramatically reduce probate costs. The cost to file in Alberta is about $500. Saskatchewan charges $7 per $1,000 of value in the estate. But she only has to file in her province of residence, which is Alberta. If Katherine disposes of the land prior to death, she’ll save a lot of money, especially when you consider legal fees involved in itemizing and valuing the estate’s holdings, which in this case could be about $400 an hour.
Then, for probate, she’d be down to an annuity, a residence and bank accounts. For the residence, she should consider making her house joint with the three kids, which would take it out of the picture for probate. I recommend she have them sign an agreement that says, “Notwithstanding the fact the children are legally on the title, Katherine remains the beneficial owner.” So, she gets to live there as long as she wants, and if she moves into a nursing home she could, for instance, collect the revenue from renting the house.
KS: We could probably get it to the point that probate isn’t even needed. If she has all the land and the residence named joint with her beneficiaries, it won’t go through probate. And if she really trusts her children, she can make them joint on the bank account as well; when she dies, she would just be removed from the account.
AS: It seems likely the children would sign that agreement stipulating she remains beneficial owner and can cause it to be returned to her sole ownership on demand.
KS: This is key. Some may argue if you transfer title, or add someone to the title, it may create a disposition for tax purposes. But, as Al explains, you can set up an agreement where, for estate-planning purposes, beneficial ownership isn’t transferred [Editor’s note: this is not possible in all provinces]. So, it’s possible to avoid probate and defer capital gains—they won’t be triggered when the kids are added to the title. And regarding the annuity, Katherine received it in a settlement and the original principal was likely tax-paid. If it increased in value, accrued unrealized gains would be taxed as capital gains on her death.
Finding wealth in the land
By Jennifer Poon, Director, Advanced Planning – Wealth, Sun Life Financial
Looking at this scenario, I can see there are a number of complex issues Katherine will have to work through with qualified tax and legal advisors. I’ll limit my comments to financial advice, focusing on three elements Katherine should consider. The first two are the transfer of wealth and the charitable donations — both of which she identified. Let’s start by discussing these.
The first step is to complete a formal appraisal and determine the value of her land. She wants to transfer her wealth as tax efficiently as possible. Once Katherine understands the potential for the land value, she can then determine how she wishes to set up her estate.
The second component is the charitable donation. Donations for ecologically-sensitive land receive donation credits that can be applied to 100% of the donor’s net income (these credits could apply against the capital gain on the rest of the land). Any capital gains on the transfer of the property are tax exempt, and the Government of Canada will certify the donation value. More information is available on the Canada Revenue Agency website.
The wild card
The third element to address is the mineral rights. In this case Katherine holds the mineral rights titles to the land. However, if a client has not secured mineral rights to their land, then I recommend speaking with them to discuss the opportunity to have a geologist survey the land to understand the value.
If a client owns the land, they may wish to secure portions that contain minerals — like oil, gas, ores and metal, or other raw materials. This way, if any minerals are extracted from the land, they would receive a portion of the profits.
Or, if your client holds the rights like Katherine does, they may wish to confirm how long they have held these for — mineral rights titles can be held for 20 to 21 years depending on the province, and can be renewed. More information on mining regulations — along with the process for each province and how long you can hold the rights — is available on the Natural Resources Canada website.
Adding to the estate
If Katherine discovers that her land has minerals in it, this could add value to her estate. By securing these rights, she now has the option to sell, develop or lease the land — depending on how she, along with her family, would like to set up the estate. Some of the common structures for this type of situation would be:
- Bare trust: The trustee holds an agency agreement to the rights, and there is no disposition for tax purposes.
- Inter-vivos trust: There’s a taxable disposition on the transfer of rights to the new trust, and the settlor (in this case Katherine) pays tax on any capital gains.
- Life estate and remainderman interest: The settlor maintains the legal title to the interest and revenue, and the rights transfer to the next generation after death.
- Family Mineral Corporation: The settlor can elect a section 85 rollover, which transfers the mineral rights to the corporation. The controlling shareholder controls and negotiates on any future transfers. If the settlor wanted to keep the land in the family instead of with beneficiaries, family members could be shareholders.
By working with clients to help them understand mineral rights, you can help them see the potential value and wealth that goes beyond their bank account. And when you work with clients and their heirs to transfer wealth, you build relationships beyond the one with your client and may discover more potential business to manage in the future.
*This is a hypothetical client. Any resemblance to real persons, living or dead, is purely coincidental.
Dean DiSpalatro is senior editor of Advisor Group.
Originally published in Advisor's Edge Report
Read this article and full issues on the iPad - click here.