23 October 2012 External T.I. 2012-0461511E5 - Replacement Property

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: 1) When does the “initial year” referred to under subsection 44(1) take place where the disposition is involuntary? 2) If a taxpayer is unable to complete the construction of a replacement property within the time limit set out in paragraph 44(1)(c) is there an administrative policy to extend this time?

Position: 1) The earliest time determined under subsection 44(2) of the Act. 2) No.

Reasons: Wording of subsections 44(1) and 44(2).

XXXXXXXXXX
2012-046151
Charles Rafuse
613-247-9237

October 23, 2012

Dear XXXXXXXXXX:

Re: Replacement Property

This is in response to your letter of September 6, 2012, concerning whether the “replacement property rules” in subsection 44(1) of the Income Tax Act (the “Act”) apply in the following situation.

The facts in your letter are briefly summarized as follows:

• In XXXXXXXXXX 2010, a XXXXXXXXXX building, owned by an individual and held for the purpose of XXXXXXXXXX, was substantially destroyed XXXXXXXXXX.
• The property was insured for its replacement cost; however, if the individual chose not to rebuild the property, a lesser amount would be paid in final settlement of the claim.
• The individual and the insurer reached an agreement as to that lesser amount shortly after the loss occurred. However, you indicate that this interim settlement is not the final settlement as the individual decided to rebuild the property and use it for exactly the same purposes as it was used before it was destroyed XXXXXXXXXX.
• The rebuilding work commenced in XXXXXXXXXX 2012, but due to the delays and the size of the project, this work is not expected to be completed until 2013.

Our Comments

Written confirmations of the tax implications inherent in particular transactions are provided by this Directorate where the transactions are proposed and are the subject matter of an advance income tax ruling submitted in the manner set out in Information Circular 70-6R5, “Advance Income Tax Ruling”, dated May 17, 2002. This Information Circular and other CRA publications can be accessed on the internet at http://www.cra-arc.gc.ca/formspubs/menu-e.html. Where a particular transaction has already been completed, a review of the relevant facts and circumstances surrounding the situation would be required. Such review would normally be conducted by the applicable Tax Services Office during the course of an income tax audit which, if undertaken, would be carried out after the particular taxpayer has prepared and filed its income tax return for the year. Notwithstanding the foregoing, we are prepared to provide the following comments that may be of assistance.

Subsections 13(4) and 44(1) of the Act permit a taxpayer to elect to defer the recognition of income (recapture) or capital gains that may arise where a “former property” is involuntarily disposed of, or a former property that is a “former business property” is voluntarily disposed of, and a “replacement property” is acquired within the specified time period. Pursuant to paragraph 44(1)(c) of the Act, where the particular property is a former property because it has been involuntarily disposed of, the “replacement property” must be acquired before the later of the end of the second taxation year following the “initial year” and 24 months after the end of the “initial year”. The “initial year” is considered to be the taxation year where an amount has become receivable by the taxpayer as proceeds of disposition of a capital property that is not a share of a capital stock of a corporation and is subject to the deeming rules in subsection 44(2) of the Act.

Subsection 44(2) of the Act provides a deeming rule to establish the time of the disposition of a property and the time at which an amount in respect of the proceeds of disposition are considered to be receivable where the taxpayer has disposed of property for which such proceeds are described in paragraphs (b), (c) or (d) of the definition of “proceeds of disposition” in section 54 (or in paragraphs (b), (c) or (d) of the definition of “proceeds of disposition” in subsection 13(21) of the Act). Generally speaking, this rule will apply to an involuntary disposition of property occurring as a result of theft, destruction or expropriation. Subsection 44(2) will deem the disposition of the property to occur and the proceeds of disposition to be receivable for the purposes of the Act at the particular day or time in which the earliest of the events described in paragraphs (a) to (e) of that subsection occur.

While a question of fact, and assuming there has been no claim, suit, appeal or any other proceeding taken by the taxpayer before any tribunal or court of competent jurisdiction, only paragraphs 44(2)(a) and (c) appear to be relevant to your particular situation. Based on the application of paragraphs 44(2)(a) and (c) of the Act, the particular time of the disposition and the receipt of the proceeds of disposition would essentially be deemed to be the earlier of:

• the day the taxpayer agrees to an amount as full compensation for the property that has been destroyed XXXXXXXXXX; and
• the day that is two years following the day the particular property was destroyed XXXXXXXXXX.

The fact that some of the insurance proceeds may have already been received does not, in and of itself, affect the application of subsection 44(2) of the Act provided that the parties have not otherwise reached a final settlement in respect of the total proceeds. However, if a taxpayer is unable to acquire a replacement property before the end of the particular time period described in subsection 44(1)(c) or (d) of the Act there is no administrative policy to extend this time period.

For additional information on the application of the replacement property rules, please refer to Interpretation Bulletins, IT-259R4 and IT-491.

We trust that these comments will be of assistance.

Yours truly

Michael Cooke
Manager
Business and Capital Transaction Section
Business and Employment Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch