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: Whether or not the replacement property rules in the Act can apply to the voluntary disposition of a mixed-use commercial building.
Position: Question of fact.
Reasons: It depends. 1) There must be a causal relationship between the acquisition of the new property and the disposition of the former. 2) The taxpayer or a person related to the taxpayer must use the particular property for a use that is the same as or similar to the use to which the taxpayer or a person related to the taxpayer put the former property. 3) Where the former property was used by the taxpayer or a person related to the taxpayer for the purpose of gaining or producing income from a business, the replacement property must also be acquired for the purpose of gaining or producing income from that or a similar business or for the use by a person related to the taxpayer for such a purpose. 4) The primary use of the former business property must be to gain or produce income from a business (it cannot be a rental property).
XXXXXXXXXX 2003-005050
Kathryn McCarthy, CA
February 9, 2004
Dear XXXXXXXXXX,
Re: Applicability of the replacement property rules to a voluntary disposition of a mixed-used commercial property
We are writing in response to your facsimile of November 21, 2003, concerning a client of yours who owns a mixed-use commercial property.
Your client is contemplating selling a commercial property, which is currently used in part by your client for a XXXXXXXXXX business and the remainder of the building is leased to other professionals. This client reports both the XXXXXXXXXX and rental revenue on an unincorporated basis. Your client is contemplating the purchase of:
1) an apartment building;
2) a commercial building; or,
3) a larger property outside of XXXXXXXXXX which would be used for a larger XXXXXXXXXX.
You inquire as to whether or not the replacement property rules in the Income Tax Act (the Act) would apply in any one of these voluntary disposition scenarios to allow your client to elect to defer possible capital gains and/or recaptured capital cost allowance.
Written confirmation of the tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an advance ruling request. An advance tax ruling request must be submitted in the manner set out in Information Circular 70-6R5, Advance Income Tax Rulings, dated May 17, 2002, which is available on our website at www.cra-arc.gc.ca. We suggest that, in this particular situation, your client should consider requesting an advance tax ruling which is a written statement given to a taxpayer stating how the Canada Revenue Agency (CRA) will interpret and apply specific provisions of existing Canadian income tax law to a definite transaction or transactions which the taxpayer is contemplating. We are, however, prepared to provide the following general comments on the application of the replacement property rules for voluntary dispositions.
In general terms, pursuant to paragraphs 44(5)(a) and 13(4.1)(a) of the Act, the replacement property rules require that it be reasonable to conclude that the new property was acquired to replace the former property. There must, therefore, be a correlation or causal relationship between the acquisition of the new property and the disposition of the former property. The fact that a property is purchased under a business expansion would not, in and of itself, mean that the property could not be considered a replacement property. Further, the geographical location of the replacement property is generally not a factor when considering whether one property is a replacement for another.
To qualify as a replacement property, paragraphs 44(5)(a.1) and 13(4.1)(a.1) of the Act provide that the taxpayer or a person related to the taxpayer must use the particular property for a use that is the same as or similar to the use to which the taxpayer or a person related to the taxpayer put the former property. Further, pursuant to paragraphs 44(5)(b) and 13(4.1)(b), where the former property was used by the taxpayer or a person related to the taxpayer for the purpose of gaining or producing income from a business, the replacement property must also be acquired for the purpose of gaining or producing income from that or a similar business or for the use by a person related to the taxpayer for such a purpose. For more information, please refer to IT-259, Exchange of Property, which is available on our website at www.cra-arc.gc.ca.
The replacement property rules in the Act permit a taxpayer to elect to defer the recognition of income or capital gains where a former property that is a "former business property" is voluntarily disposed of, and a "replacement property" is acquired. Subsection 248(1) defines "former business property" to mean capital property that was used by the taxpayer or a person related to the taxpayer primarily for the purpose of gaining or producing income from a business, and that was real property or an interest in real property, but does not include rental property or land subjacent to a rental property of the taxpayer. Whether or not a particular mixed-use commercial property can be considered a "former business property" is a question of fact. For more information, please refer to IT-491, Former Business Property, which is available on our website at www.cra-arc.gc.ca.
"Rental property" is excluded from the definition of "former business property" and is further defined to mean real property owned by the taxpayer and used in the particular year principally for the purpose of gaining or producing gross revenue that is rent. Accordingly, even though a property is used to earn qualified business income, it would be disqualified as a former business property if it was used in the taxation year in which it was disposed of principally for the purpose of producing rent. However, if a property is leased by the taxpayer to a person related to the taxpayer and is used by that related person principally for any purpose other than gaining or producing gross revenue that is rent, it is not included in the definition of rental property.
Where property is used in part to earn gross revenue that is rental income and in part to earn income from a business other than rental income, the principal use of the property is determined on the basis of the facts in the particular case. The word "principally" is considered to mean "mainly" or "chiefly" and, accordingly, one should look to the main or chief purpose or intent for which the property is used by the owner. One of the prime factors to consider is the actual or physical proportion of the property used in the two income-earning processes. Other potential factors to consider may include: income or gross revenue from each operation; profits realized from each operation; capital employed in and the rate of return from each operation; time, attention and effort expended in each operation; and, the motivation or intent of the taxpayer in making the investment together with the ultimate utilization of the property.
We trust our comments will be of assistance to you.
Yours truly,
John Oulton, CA
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Policy and Planning Branch
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