(Note this column originally ran Feb. 5, noted to be Quiz #1)
This tax season, let’s challenge your knowledge on personal tax.
Well here is one in a series of typical tax planning and preparation situations to test you.
Ok, let’s say you have a regular full time job and you also operate a farm that grows some cash crops plus you raise chickens. You also happen to live on the farm property.
In 2019 you turned another loss. This year it was $50,000. You have had losses almost every year for the better part of a decade.
Is the $30,000 farming loss a deduction that can be netted against your other income?
Given the continuous annual losses, Canada Revenue Agency (CRA) would likely review the farm operation and determine this farm is a hobby, and not a business. In other words, it’s not likely this farm will turn a profit, and in fact CRA would argue that the owner has no profit motive, especially considering the owner works full time at a regular job.
However, in the case of a farm determined to be a business operation, the allowable loss that can be claimed on a tax return is calculated by taking only $2,500 of the first $10,000 of loss and adding 50% of the remaining balance of the loss. In this case, it would be 50% of $40,000, so $20,000 plus the $2,500 for a total loss of $22,500. This is referred to as a “restricted farm loss”. This reduced loss calculation is used because of the favorable tax regime CRA affords farming businesses in general.
Now let’s say you don’t live on the farm property. Is the farm operation then automatically considered a business operation?
No. Where you live is not relevant.
A scenario that doesn’t involve a farm. Let’s say you have a regular full time job and you also run a computer repair business out of your home. You have a loss almost every year, or at best you breakeven. Can you use the business loss against your other income?
Just like the farm, it depends. As each successive year goes by that you claim the business loss on your tax return, the odds increase for a CRA review. At that time, CRA will likely determine your operation is a hobby and not a for-profit business operation, and the loss will be denied. In fact, CRA could deny losses claimed in past years and re-assess those tax returns and require tax, penalties and interest be remitted to CRA.
On that note, in 2017 CRA announced that taxpayers reporting a “prolonged period of business losses” may be subject to review. Reading further, “prolonged period of business losses” is defined as business losses reported for two consecutive years. Yes, two years. New business start-ups not exempted.