Replacement Property Rules
Replacement Property Rules – Deferring a Capital Gain
Normally, if you sell a property at a higher amount than the purchase price, there will capital gains taxes payable. However, sections 44, and 44.1 of the Income Tax Act allow for the capital gain to be deferred until the sale of a property purchased to replace the former property, if certain conditions are met.
This section allows for the deferral of a capital gain where there was an involuntary disposition. This would occur where the property has been stolen, destroyed, or expropriated. It also allows for the deferral if the capital gain was from the sale of real estate used by a taxpayer to earn business income. You should be aware that rental properties are specifically excluded by this section.
This section limits its application to the sale of certain Canadian Controlled Private Corporation shares. The corporation’s assets must be used in an active business, and the value of the assets must be less than $50,000,000.
Eligible Criteria and Timing
According to Canada Revenue Agency publication IT-259R4, there are rules that taxpayers must meet for the replacement property to qualify for the deferral. The four you should be aware of are as follows:
- The property was purchased to replace the former property.
- The property was purchased for a similar purpose as the former property was being used for.
- The property was purchased to gain or produce income from the same, or a similar business as the former property.
- If the replacement was voluntary, the purchase must occur within one year from the end of the taxation year of the sale of the former property. If the replacement was involuntary, the purchase must occur within two years from the end of the year the insurance proceeds became available (receivable).
In order to make use of the deferral, taxpayers must make an election in their tax returns in the year the replacement property was purchased. You should also keep in mind that in order to defer the entire gain, you must use all the funds you received from the sale of the former property, when purchasing the replacement property.
Section 1031 of Title 26 to the U.S. Code is a broader version of Canadian Income Tax Act sections 44, and 44.1. If a taxpayer meets the requirements of this section, a gain on a sale may be deferred as above, until the sale of the replacement property. This is known as a 1031 exchange. However, Section 1031 is far more broad than its Canadian counterpart. Situations may arise where a gain may be deferred in the United States, but will be taxable here in Canada. Canadian taxpayers with properties in the United States should seek legal assistance when attempting to take advantage of this deferral as double taxation by the U.S. and Canadian governments becomes a real possibility.
Deferring a capital gain on the sale of property may be an excellent tax planning opportunity. Taxpayers must be aware of the various rules associated with the deferral and need to be careful not to run afoul of those rules. Here at R&A Tax Law, we have the experience and the expertise to ensure this is a smooth process. Give us a call today to see what we can do for you!
Livingston v. The Queen, 2015 TCC 24 – What is Replacement Property?
Grove Acceptance Ltd. v. The Queen, 2002 CanLii 1120 – Business or Rental Property?
St-Jean v. The Queen, 2008 TCC 358 – What Constitutes Business Property?
This article provides information of a general nature only. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in this article. If you have specific legal questions you should consult a lawyer.