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. Whether land in excess of 1/2 hectare is part of principal residence in a particular situation. 2. Whether the environmentally protected land is subject to capital gains tax. 3. Whether any of the land is qualified farm property.
Position: 1. Possibly. 2. Yes. 3. No.
Reasons: 1, 2, 3 - See comments.
XXXXXXXXXX 2011-042338
Tim Fitzgerald, CGA
November 3, 2011
Dear XXXXXXXXXX :
Re: Disposition of Farm Property
This is in reply to your E-mail correspondence of October 5, 2011 regarding the application of the principal residence exemption and/or the capital gains exemption for a disposition of your farm property under the Income Tax Act (Canada) ("Act").
We understand that you inherited XXXXXXXXXX acres of land (the "Property") from your mother as a consequence of her death in XXXXXXXXXX . You indicated that your parents never farmed the Property. The Property included a house, which you lived in, a barn and a XXXXXXXXXX business for approximately XXXXXXXXXX years. The house was set back from the road. You also indicated that XXXXXXXXXX of the XXXXXXXXXX acres were rented out to a local farmer who farms the land while approximately XXXXXXXXXX to XXXXXXXXXX acres were classed as environmentally protected lands. The remaining land was used by you to carry on your XXXXXXXXXX business.
You recently sold the Property and have the following questions concerning the tax treatment of the capital gain on disposition of the Property. First, you would like to know if one hectare of the land subjacent the house, including the entire driveway, can be considered part of your principle residence for purposes of claiming the principal residence exemption. Second, you would like to know if the portion of the gain attributable to the environmentally protected lands is subject to capital gains tax. Finally, you would like to know if any portion of the gain on the disposition of the Property would be eligible for the capital gains exemption.
Our Comments:
Although your situation involves completed transactions, we are, prepared to offer the following general comments, which may be of assistance.
Principal Residence Exemption
In general terms, if a property qualifies as a taxpayer's principal residence, the taxpayer can use the principal residence exemption to reduce or eliminate any capital gain otherwise occurring for income tax purposes on the disposition of the property. The term "principal residence" is defined in section 54 of the Act. The principal residence exemption is claimed under paragraph 40(2)(b) of the Act, or under paragraph 40(2)(c) where land used in a farming business carried on by the taxpayer includes the taxpayer's principal residence.
Based on the definition of principal residence, if the total area of the contiguous land upon which a housing unit is situated exceeds one-half hectare (approximately 1.24 acres), the excess land is deemed not to be part of the principal residence unless the taxpayer establishes that such excess land is necessary for the use and enjoyment of the housing unit as a residence. The onus is on the taxpayer to establish how much, if any, of the excess land is necessary for the use and enjoyment of the housing unit as a residence.
Generally, a taxpayer's use of land in excess of one-half hectare in connection with a particular lifestyle does not, in and of itself, mean that such excess land is "necessary" for the use and enjoyment of the housing unit as a residence. Land in excess of 1/2 hectare could be necessary where the location of a housing unit requires such excess land in order to provide its occupants with access to and from public roads. Other factors may be relevant in determining whether land in excess of one-half hectare is necessary for the use and enjoyment of the housing unit as a residence, such as, for example, a minimum lot size or a severance or subdivision restriction. In all cases, however, it is a question of fact as to how much, if any, of the excess land is necessary for the use and enjoyment of the housing unit as a residence.
Capital Gains Exemption
Generally, subsection 110.6(2) of the Act permits a capital gains exemption of up to $750,000 for an individual who is resident in Canada throughout the year and disposed of "qualifying farm property" ("QFP") in the year. In respect of an individual (other than a trust that is not a personal trust), the definition of QFP in subsection 110.6(1) of the Act includes "real or immovable property that was used in the course of carrying on the business of farming in Canada" by certain qualifying users including the individual, spouse, common-law partner, child, parent of the individual, or a partnership, an interest in which is an interest in a family farm partnership of the individual or of the individual's spouse or common-law partner (referred to hereafter as "Qualifying Owners").
A property of an individual must meet one of two general farming-use tests to be considered to be used in the course of carrying on the business of farming in Canada. The two farming-use tests are set out in subsection 110.6(1.3) of the Act (as proposed to be amended by draft legislation released to the public on November 5, 2010). The applicable farm use test will essentially depend on when the taxpayer last acquired the particular property. Since we understand that you last acquired the property after June 17, 1987, the applicable farm use test is as follows.
The first farming-use test is made up of two parts. The first part is that the property of an individual must satisfy an ownership period in that it must have been owned continuously by one or more Qualifying Owners, throughout a period of at least 24 months immediately preceding the disposition. The second part of this farming-use test is that in at least 2 years during the mentioned ownership period, the gross revenue from the farming business that was carried on by the operator (being a person in the list of Qualifying Owners) in which the property was principally used (i.e., more than 50%), and in which a person in the list of qualifying owners was actively engaged on a regular and continuous basis, must have exceeded the operator's income from all other sources for the year. The second part of the test may also be satisfied (in the alternative) if throughout a period of at least 24 months during the ownership period mentioned above the property was used by a corporation, a share of the capital stock of which is a share of the capital stock of a family farm corporation, or by a partnership, an interest in which is an interest in a family farm partnership, in a farming business in which a person in the list of Qualifying Owners was actively engaged on a regular and continuous basis.
In our view, the operator meeting the gross-revenue requirement above need not be the individual who disposes of the property. For example, if, while the operator owned the property, the property was used by the operator principally in a farming business in which the operator was actively engaged on a regular and continuous basis and the operator has met the gross-revenue requirement mentioned above, the property will qualify as QFP in the hands of the operator and as well, in the hands of a child of the operator to whom the property is transferred by the operator.
You have not provided sufficient information that would allow us to determine whether your farming activities actually constituted a business; whether you were actively engaged on a regular and continuous basis in a farming business; or whether you earned sufficient gross revenue during the applicable ownership period. However, while the ability to claim a capital gains exemption remains a question of fact, it appears from the limited information that you have provided that you would not be able to meet the second part of the farm use test described above. This is because most of the land (i.e., XXXXXXXXXX of XXXXXXXXXX acres) was used to generate rental income and if that is the case, such land would not have been principally used by you in a farming business. As noted in paragraph 9 of Interpretation Bulletin, IT-433R, Farming or Fishing - Use of Cash Method, we generally consider income derived by a landlord from renting farm land (even under a sharecropping arrangement) to be income from property and not from farming. It also appears that the environmentally protected land would not be QFP nor would such land be "necessary" for the use and enjoyment of the housing unit as a residence, such that no portion of the capital gain that is attributable to the environmentally protected lands would appear be shielded from the capital gains tax.
Accordingly, it appears that only a portion of the capital gain arising on disposition of the Property might be shielded from the capital gains tax (i.e., the portion of the capital gain attributable to your principal residence, which includes up to 1/2 hectare of the land subjacent to the housing unit and, in addition, possibly the land that is needed to access the public roadway).
In closing, a review of the relevant facts and circumstances surrounding the situation would be required to conclusively resolve these matters. Such review would normally be conducted by your Tax Services Office during the course of an income tax audit which, if undertaken, would be carried out after you have prepared and filed your income tax return for the year. In terms of preparing your income tax return for the year, you may wish to obtain the advice of a professional tax advisor.
We trust our comments above are of assistance.
Michael Cooke, C.A.
Manager
For Director,
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Division
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