Translation disclaimer
This translation was prepared by Tax Interpretations Inc. The CRA did not issue this document in the language in which it now appears, and is not responsible for any errors in its translation that might impact a reader’s understanding of it or the position(s) taken therein. See also the general Disclaimer below.
Principal Issues: [TaxInterpretations translation]
Should the terminal loss incurred on the disposition of a building that was moved off the land shortly before the sale be capitalized as part of the cost of the land?
Is the terminal loss on the building acceptable, given that it mainly reflected moving costs incurred?
Should a portion of this loss be capitalized as an eligible capital property?
Position:
Yes, to a certain extent
The terminal loss is not acceptable
No
Reasons:
According to the CCRA's position in paragraph 6 of IT-128R, paragraphs 7 and 8 of IT-220R2 and paragraph 6 of IT-485. The building is not depreciable property by virtue of paragraph 1102(1)(c) of the Regulations. In addition, the moving expenses were incurred specifically to vacate the land.
March 5, 2002
XXXXXXXXXX Tax Services Office Headquarters
Lucie Vermette, CGA
Attention: XXXXXXXXXX (613) 957-2092
2001-010275
Request for an opinion regarding terminal loss on a building
This is in response to your letter of September 20, 2001, in which you requested our opinion on the above subject. We apologize for the delay in responding to your request.
THE FACTS
XXXXXXXXXX
QUESTIONS
You would like our opinion as to whether the loss incurred on the sale of the building, shortly after it was moved, was deductible as a terminal loss or whether this loss, which for the most part represented costs incurred during the move, must be capitalized to the cost of the land on which the building was originally erected at the time of purchase.
You would also like our opinion on whether a portion of this loss can be considered as eligible capital property.
YOUR POSITION
You consider that XXXXXXXXXX purchased and moved the building in order to free up the land on which it was located in order to increase the parking space and visibility of the adjacent buildings that it owned. You are of the view that the taxpayer did not have to move the building because the property was already generating income and the move did not increase that income. Your position, according to your draft assessment, is to deny the terminal loss in its entirety, based on paragraph 6 of Interpretation Bulletin IT-485, considering the move comparable to a demolition.
POSITION OF THE TAXPAYER
The taxpayer stated that the purpose of the purchase of the land and building was indeed to enlarge the parking lot and improve the visibility of the other buildings, but it was also intended to earn income from both the building and the other rental properties located near the vacated land. The assets were acquired and disposed of between parties dealing at arm's length and the value attributed to them represents fair market value. The taxpayer sold the building because he had problems with certain tenants.
In order to answer your principal question, i.e. whether the loss incurred by XXXXXXXXXX on the sale of the relocated building should be considered a terminal loss, we will analyze the tax implications chronologically.
The purchase in XXXXXXXXXX
Although most of the $XXXXXXXXXX terminal loss represents moving expenses in the amount of $XXXXXXXXXX, we must first consider the $XXXXXXXXXX balance of this loss, which corresponds to the difference between the sale price of the building ($XXXXXXXXXX) and the value assigned to it when it was acquired in XXXXXXXXXX ($XXXXXXXXXX), less the capital cost allowance claimed ($XXXXXXXXXX). With respect to the value attributed to the building at the time of purchase in XXXXXXXXXX, the following should be considered.
In the context of the sale of land and a building, section 68 of the Income Tax Act (the "Act") provides that an allocation of the total sale price between the different properties must be made in a reasonable manner. This reasonable allocation will be the same for the vendor and the purchaser. In addition, the guidelines issued in paragraphs 7 and 8 of Interpretation Bulletin IT-220R2 indicate that where a demolition of a building took place shortly after its acquisition and the total selling price exceeded the fair market value of comparable land because the purchaser had a special reason for wanting that particular property, it may be reasonable to conclude that the vendor received for the building an amount equal to the excess over the fair market value of the land alone, and that the purchaser is deemed to have paid that amount for the building.
In this situation, the fact that the allocation of the purchase price was based on the municipal assessment does not provide any certainty as to the reasonableness of the value attributed to the building. We strongly encourage you to call on the services of the real estate appraisal section of your Tax Services Office to verify the validity of the allocation of the purchase price between the building and the land. In our opinion, given the facts you have submitted to us, the amount allocated to the building at the time of purchase appears to have been an overestimate. In light of the foregoing, it would be appropriate to reassess the allocation of the purchase price in XXXXXXXXXX based on the guidelines set out in Interpretation Bulletin IT-220R2 and the opinion obtained from your internal appraisers. This new allocation, if applicable, would reduce the loss on disposition of the building.
The move in XXXXXXXXXX
The moving expenses of $XXXXXXXXXX were capital in nature since they were non-recurring and provided an enduring benefit. They must therefore be capitalized and were not deductible in computing income by virtue of paragraph 18(1)(b). Considering that moving costs produce the same result as demolition costs, i.e., freeing up the land, paragraph 6 of Interpretation Bulletin IT-485 states the following:
6. In some cases a taxpayer may buy a piece of real estate, including a building with the intention of tearing down the building. Where the taxpayer has not used the building to earn income, it would seem clear that the purchase price was paid for the land and might even have been greater if the building had not been on it. In these circumstances, the cost of demolishing the existing structure, less the amount of any salvage, will form a part of the cost of the land.
Where a building has been acquired in the circumstances outlined above but has been rented for a short period before demolition, the above rule applies, but the net rental income therefrom may be applied in reduction of the cost of the land.
In the current situation, we are of the view that most of the moving costs of $XXXXXXXXXX should be added to the cost of the cleared land since the purpose of the move was to clear the land rather than to advantageously locate the building.
A detailed analysis of the moving costs could allow a certain portion of these costs, which cannot be dissociated from the building itself, to be capitalized to the building being moved. In addition, it may be appropriate to consider capitalizing part of the removal costs under Class 17 of Schedule II to the Income Tax Regulations (the "Regulations") if those costs related to the construction of the new parking area on the vacated land.
Depreciable property
Paragraph 1102(1)(c) of the Regulations states that the classes of property described in Part XI and Schedule II of the Regulations do not include property that was not acquired by the taxpayer for the purpose of gaining or producing income.
In addition, paragraph 6 of Interpretation Bulletin IT-128R states that where the building is used to earn income for only a short time prior to demolition, it is not regarded as depreciable property unless the taxpayer can clearly establish that the prime intention on acquiring the building was for the purpose of gaining or producing income.
According to the information you sent to us, XXXXXXXXXX indicated that it had acquired the land and building with a view to generating rental income. In a letter dated September 11, 2001, XXXXXXXXXX's representative stated that the anticipated rental income includes not only the income from the building that was moved, but also the income from the tenants of the other buildings owned by XXXXXXXXXX and located around the vacated land.
The taxpayer may have intended to generate income when he acquired the land and building, but this intention seems to have been primarily directed at XXXXXXXXXX's other properties and not at the building acquired. In fact, the move corroborates the taxpayer's intention and is an important fact in the series of transactions listed in your letter. In addition, the fact that the building had to be moved as is in order for the XXXXXXXXXX to grant XXXXXXXXXX a permit to use the land as a parking lot indicates the importance that the taxpayer attached to the land. In our view, the taxpayer's primary intention was to free up the lot in order to expand the parking lot and give greater visibility to the other businesses located on the site. The move was not made with the aim of generating income from the building, since it was already generating income and, furthermore, the move does not appear to have improved the building's ability to generate income.
In this regard, we refer you to the case of Burrows Motors Limited v. MNR, 55 DTC 172 (ITAB), in which a decision was rendered as to the primary intention of a taxpayer in acquiring two parcels of land on which rental properties were built. In that case, the judge concluded that the taxpayer's primary purpose was not to generate income from the rental properties but rather to use the land to expand his business, since he had sold and moved the rental properties shortly after acquiring them.
In view of the foregoing, in our view, the building does not constitute depreciable property by virtue of paragraph 1102(1)(c) of the Regulations and, consequently, the capital cost allowance previously claimed by the taxpayer should be cancelled.
Sale in XXXXXXXXXX
The concept of terminal loss in the Act applies to depreciable property of a class prescribed by Regulation. As stated above, the building does not constitute depreciable property by virtue of paragraph 1102(1)(c) of the Regulations. Consequently, no terminal loss could be allowed pursuant to subsection 20(16).
Following a reallocation of the amount paid at the time of purchase in XXXXXXXXXX between the building and the land, and considering the possibility of capitalizing only certain expenses included in the $XXXXXXXXXX incurred during the removal of the building, a loss could still result from the sale of the building in XXXXXXXXXX. If the transaction had occurred in connection with an adventure or concern in the nature of trade determined in accordance with the criteria set out in paragraph 3 of Interpretation Bulletin IT-218R, the taxpayer could have sustained a business loss. On the other hand, if we consider that the sale of the building is more in line with the concept of a capital investment, XXXXXXXXXX would have sustained a capital loss. Although this is a question of fact, we are of the view that in the current situation, the building should receive the same treatment as the cleared land since it appears to have been acquired incidentally to the land, which appears to be a capital investment.
Regarding your last question, namely, whether part of the loss can be considered an eligible capital property, it is our opinion that although benefits may result from the acquisition and conversion of the land following the building's relocation, none of the amounts paid out in this situation can qualify as an eligible capital property since the amounts were invested essentially for the acquisition and development of the land.
For your information, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Customs and Revenue Agency's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, the electronic library version can be provided. Alternatively, the client may request a severed copy using the Privacy Act criteria, which does not remove client identity. Requests for this latter version should be made by you to Ms. Jackie Page at (819) 994-2898. A copy will be sent to you for delivery to the client.
Should you require any additional information concerning this document, please do not hesitate to contact us.
Best regards,
Ghislaine Landry, CGA
Manager
Individuals, Business
and Partnerships Section
Business and Partnerships Division
Income Tax Rulings Directorate
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