19 January 2005 External T.I. 2004-0099311E5 - Replacement Property-Involuntary Disposition

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: A rental property was destroyed by fire in 2002. The insurance company made an initial payment in 2003 and a final payment in 2004. The total proceeds of disposition received from the insurance company exceed the original cost of the property. The rebuilding of the site is to be completed in 2005 or 2006. Whether the replacement property provisions apply in this situation to allow an individual taxpayer a deferral of the capital gain.

Position: Question of fact. The issue is what day the taxpayer agreed to the full amount of compensation for the property.

Reasons: If no claim, suit, appeal or other proceeding has been taken before a tribunal or court of competent jurisdiction within 2 years from the date of the destruction of the property, the earliest day of deemed disposition would be the earlier of the day the amount of compensation is agreed to and 2 years from the date of the fire. The replacement rental property must be acquired within 2 years of the deemed involuntary disposition in order to qualify for a deferral of income or capital gains under the replacement property rules

XXXXXXXXXX 		2004-009931
		Kathryn McCarthy, CA
January 19, 2005

Dear XXXXXXXXXX,

Re: Replacement Property Rules - Involuntary Disposition of a Rental Property

We are writing in response to your e-mail of October 20, 2004, concerning the above noted subject.

You described a situation where a rental property was destroyed by fire in 2002. The insurance company made an initial payment in 2003 and a final payment in 2004. The total proceeds of disposition received from the insurance company exceed the original cost of the property. The rebuilding of the site is to be completed in 2005 or 2006. You enquire whether the replacement property provisions of the Income Tax Act (the Act) apply in this situation to allow an individual taxpayer a deferral of the capital gain.

Our Comments

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 submitted in the manner set out in Information Circular 70-6R5, Advance Income Tax Rulings, dated May 17, 2002. Where the particular transactions are completed, the inquiry should be addressed to the relevant Tax Services Office. We are, however, prepared to provide the following general comments.

Generally, subsections 13(4) and 44(1) of the Act permit a taxpayer to elect to defer the recognition of income or a capital gain where a "former property" is involuntarily disposed of and a "replacement property" is acquired. Where all the applicable conditions are met, these rules allow taxpayers that have lost a rental property to rebuild and defer the resulting tax consequences to the extent provided in the Act. The replacement property must be acquired to replace the former property and have the same or similar use as the former property.

Where the former property (other than eligible capital property) has been involuntarily disposed of, for example destroyed by fire, the replacement property must be acquired within two taxation years of the end of the taxation year in which the disposition of the property is deemed to have occurred and proceeds to have become receivable. Draft legislation, if enacted, will allow the replacement property to be acquired at the later of two taxation years from the end of the taxation year in which the property is deemed to be disposed and 24 months after the end of the year. The draft legislation proposes to make this change applicable to dispositions that occur in taxation years ending after December 19, 2000.

Subsection 44(1) of the Act provides for the deferral of a capital gain on the disposition of a capital property where the "proceeds of disposition" include insurance proceeds payable for property destroyed, as described in paragraph (c) of the definition of "proceeds of disposition" in section 54 or subsection 13(21). In addition, the recapture of capital cost allowance on the disposition of a property described above that is depreciable property of a prescribed class may be deferred by virtue of subsection 13(4).

Subsection 44(2) deems the disposition to occur and the proceeds to be receivable in the year in which the earliest of certain events occur. These include:

a) the day the taxpayer agrees to the full amount of compensation for the property; or

b) when two years have elapsed after the destruction of the property if no proceeding before a tribunal or court has been taken before that time.

In the situation you describe, if no claim, suit, appeal or other proceeding has been taken before a tribunal or court of competent jurisdiction within 2 years from the date of the destruction of the property, the earliest day would be the earlier of the day the amount of compensation is agreed to and 2 years from the date of the fire. For example, if the taxpayer agreed to the full amount of compensation in 2002, that would be the earliest time and the disposition of the rental property would be deemed to occur in 2002. A replacement rental property, therefore, would have to be acquired before 2005 (within 2 years of the deemed involuntary disposition) in order to qualify for a deferral of income or capital gains under the replacement property rules in the Act. If the taxpayer agreed to the compensation in 2003, the replacement property must be acquired before 2006. Otherwise, the replacement property would have to be acquired before 2007.

For more information, please refer to Interpretation Bulletin IT-259R4, Exchange of Property, which is available on our website at http://www.cra-arc.gc.ca/E/pub/tp/it259r4/Top.

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