Offsetting Farm Losses Against Other Income

Question

I’d like to minimise my tax when developing a small farm. We’ve recently bought a 28 acre block, and will run a farm which will get us primary producer status as we meet the ATO requirements for that. The block has a house that we’re going to rent out and negatively gear.

We’re planning to spend at least $50K on improvements on the block in the first 12 months. For instance we’re likely to spend $30K on a shed/barn, mains cabling will be $5-10K, septic system, green house, fencing supplies, machinery etc. There will also be ongoing business expenses, purchase of stock, feed and so on.

I’m not sure how we structure our spending and farm business to minimise tax. Do we need to setup the farm as a company? Or do we run it as a partnership between my wife and myself. I do have a non-trading company which could be used if required so there’s no additional cost to being a Farm Business Pty Ltd. If the farm is a company do we lease the land to that company? How does that impact on negative gearing?

We have a family trust, and the income from my consulting is distributed to us through that trust. Could we have a holding company with the farm and the consulting arms, and use that to move consulting income into the farm without having to pay tax?

Our ideal outcome is that our personal taxable income is decreased by any/all spending on items for the farm. That’s important in this tax year to minimse our tax from the capital gain, but it will also be useful ongoing.

I’ve looked at https://www.ato.gov.au/business/non-commercial-losses/four-tests/ and I’m not sure if that applies to our circumstances. We may make $20K income but that will be tight, especially in year 1. Similarly we may meet the $500K in real property test – the buy price was more than $500k. We maybe profitable in 3 of 5 years but our business plan is investment heavy in the early years so profit will take time and is by no means certain in the first 5 years.

I’m aware that there are many questions in this, so would be happy to pay an appropriate surcharge. I’ve been looking at your advice for years, and it’s been useful and good to read – many thanks


Answer

“Thank you so much for allowing this question to be posted.”

The $30k you spend on a shed/barn is going to have to be written off over 40 years so not much there, nevertheless it sounds like the farm will make a loss that will be useful to offset against your capital gain this year.  On the surface it appears your consulting business is personal services income https://www.bantacs.com.au/booklets/Alienation_Of_Personal_Services_Income.pdf  Even if you pass the 80/20 rule because it is earned from your own efforts and you do not employ anyone else that provides the same services as you, the income is not from a business.

Passing the 80/20 rule allows you to pay a spouse to do admin work or run a few cars through the business but won’t let you just distribute profits to whoever you like

Some relevant paragraphs from IT 2639:

Paragraph 10

  1. a)  If the practice company or trust has at least as many non-principal practitioners (see paragraph 11) as principal practitioners, then income is considered to be derived from the business structure.

Paragraph 11. In paragraph 10:

  1. “Practitioners” include both full-time professional and non-professional staff whose function is to derive material fees for the practice. Part-time staff count proportionately. The term does not include administrative, clerical or support staff. For example, a nurse under the direction of a doctor or a legal secretary under the direction of a solicitor are not “practitioners” unless they earn material fees in their own right.

For more detail here is a link to my blog  https://bantacs.com.au/Jblog/psi-contractors-splitting-income/#more-330

This means the trading entity can only distribute the consulting income to you.  Further, trusts and companies cannot distribute a loss (with the one exception of when the income is from personal services).

So what this boils down to is you and your spouse are stuck with the income you are earning and the capital gain and the rental income, in your personal tax return, no avoiding that.  The only way the farming loss will become useful this year is if you can get that into your personal tax returns too.   To go into both returns you will need to farm as a partnership.  Otherwise one of you can operate the farming business as a sole trader if you prefer all the loss to go to one spouse.    Of course this may all come back to bite when the farm starts making a profit.  By then you may have retired so it won’t matter.

If you choose to run the farm in  a partnership or sole trader be aware that there is no corporate veil for asset protection.  You need to discuss this in more detail with your Accountant who would know your circumstances better than me.

The next step is to make sure you are not caught by Div 35 – the non commercial loss rules https://www.bantacs.com.au/booklets/Division_35_Offsetting_Business_Losses_Booklet.pdf   The $20,000 income tests allows you to argue that if you had operated for a full year you would have made $20k.    Please leaf through the booklet to see the consequences of your income reaching $250k.”

The $500k real property test is based on the CGT cost base, see the legislation below:

35-40(1)

View history reference

The rules in section 35-10 do not apply to a * business activity for an income year if the total * reduced cost bases of real property or interests in real property used on a continuing basis in carrying on the activity in that year is at least $500,000.

View history note

35-40(2)

View history reference

You may use the *market value of the real property or interest if that value is more than its * reduced cost base.

35-40(3)

View history reference

The * reduced cost base or *market value is worked out:

(a) as at the end of the income year; or

(b) if you stopped carrying on the * business activity during the year:

(i) as at the time you stopped; or

(ii) if you disposed of the asset before that time in the course of stopping carrying on the activity – as at the time you disposed of it.

35-40(4)
However, these assets are not counted for this test:

(a) a * dwelling, and any adjacent land used in association with the dwelling, that is used mainly for private purposes;

(b) fixtures owned by you as a tenant.

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