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: Is the cottage considered part of the land?
Reasons: Where both the cottage and land are used as personal-use-property, if the cottage built on the land forms a substantial connection with the land and the purpose of annexing the cottage to the land is to improve the use of the land, then the principles in property law would consider the cottage to be part of the land.
December 4, 2013
Compliance Programs Branch HEADQUARTERS
Specialty Audit Division Income Tax Rulings
Attention: Claudio DiRienzo Henry Leung
Personal-use-property and paragraph 9 of Article XIII
This is in response to your e-mail of May 16, 2013, regarding the question of the application of paragraph 9 in Article XIII of the Canada-U.S. Tax Convention ("Treaty") as it pertains to personal-use-property.
The facts in your situation are as follows:
A U.S. resident owned vacant land on XXXXXXXXXX. The land remained vacant and continued to be held by that U.S. resident until XXXXXXXXXX. In XXXXXXXXXX, the U.S. resident built a cottage on that land. Both the land and cottage are personal-use-property ("PUP"), as defined in subsection 54(1) of the Income Tax Act ("Act"). The land and the cottage were disposed of in a subsequent year.
You ask for our views on how the two properties will be treated upon their disposition for the purposes of applying the Act and paragraph 9 of Article XIII of the Treaty. If both assets are considered as one property, then there is only one gain to be reported, and this gain would be eligible for the benefits under paragraph 9 of Article XIII of the Treaty. Moreover, only one section 116 certificate will need to be filed. On the other hand, if the land and the cottage are considered separate assets then only the land will qualify for the benefits under paragraph 9 of Article XIII. The capital gain on the building will need to be calculated separately. In such an instance, since there are two separate gains being determined, two separate notifications would be required under section 116 of the Act.
The taxpayer's representative takes the view that the cottage and the land are combined and considered as part of the land. In their view, since the cottage is part of the land, upon the disposition of both assets, the total capital gain will be eligible for the benefits of paragraph 9 of Article XIII of the Treaty and accordingly, only one section 116 certificate will need to be filed.
Under common-law principles, generally, whatever is attached to the land becomes a part of it. The determination of whether or not an object has become sufficiently attached to the land (i.e. a fixture), requires the consideration of the:
- Degree of Annexation, and
- The Purpose of Annexation.
The degree of annexation requires some substantial connection with the land or a building on it to be established, and a key consideration is whether the building can be removed from the land without injury to itself or to the land. In assessing the purpose of annexation, one would need to consider whether the intention was to effect a permanent improvement to the land, or was it merely to effect a temporary improvement or to enjoy the article attached as a chattel.
While common-law principles would establish that only one property exists when something built on it has a substantial connection with the land and the purpose of that construction is to effect a permanent improvement on it, for tax purposes, certain property may meet the definition of "depreciable property" in subsection 13(21) of the Act. As "depreciable property", such property may be eligible for CCA deductions. In such an instance, subsection 1102(2) of the Income Tax Regulations ("Regulations") specifically excludes land from any of the CCA classes in Schedule II of the Regulations. As such, the land would be separated from the building in determining what CCA class the property falls into.
In this particular case though, both the building (the cottage) and the land are PUP. As defined in section 54 of the Act, PUP is property owned and used primarily for the personal use or enjoyment of the taxpayer. Paragraph 1102(1)(c) of the Regulations excludes property from being included in the CCA classes where the property was not acquired by the taxpayer for the purpose of gaining or producing income. Therefore, PUP held purely for personal use cannot fall into the definition of "depreciable property" under subsection 13(21) of the Act. This is because the two terms are mutually exclusive, and the taxpayer was not or would not have been allowed to make a CCA deduction under paragraph 20(1)(a) of the Act if the taxpayer owned the property at the end of that year.
Since the property in this case is PUP, subsection 1102(2) of the Regulations is irrelevant. Therefore we need only to rely on the common-law principles laid out above in determining whether the cottage should be considered to be part of the land. If the cottage is substantially connected to the land and permanently improves the land, then it is our view that the cottage constructed on the property is a fixture and becomes part of the land on which it is situated.
Such a view would be consistent with CRA's views on how property is treated for the purposes of the determination of the principal residence exemption. As it relates to the principal residence exemption, when a taxpayer acquires vacant land in one year and then constructs a housing unit on the land in a subsequent year, variable C (the total number of years that the taxpayer owned the property) of the formula of the principal residence exemption in paragraph 40(2)(b) of the Act, includes in it (in addition to the time period the home is inhabited as a principal residence), the time the land was vacant and the time the home was under construction on the land. Although the calculation of the principal residence exemption pro-rates the gain to be exempted only for the portion of the time from the date that the taxpayer commences to ordinarily inhabit the housing unit, the determination of the exemption shows that the home and the land are treated as one property once the home is built on it and there is only one disposition when the property is ultimately sold. Therefore, if in the principal residence exemption determination, there is no separation of the land and the building that is built on such land, it makes sense that where such property is personal-use-property, for the purposes of the determination under paragraph 9 of Article XIII of the Treaty, there should be a similar treatment.
Assuming the criteria in the common-law principles are met in this case, on the actual disposition of the cottage and the land, it is our opinion that together, they should be considered the disposition of only one property. In such an instance, even though the cottage is constructed after XXXXXXXXXX, the cottage should be treated as an addition to the land and be considered as part of the "capital asset" that is owned by the U.S. resident on XXXXXXXXXX. Therefore, the total gain from the sale of both the cottage and the land will be eligible for the reduction provided for under paragraph 9 of Article XIII. Since only one property is considered to be disposed of, only one notification is required under section 116 of the Act.
We trust that these comments will be of assistance.
Olli Laurikainen, CPA, CA
Income Tax Rulings Directorate
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