17 December 1988 Income Tax Severed Letter 7-2950 - [Conversion of Capital Property to Inventory]

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.

DEC 17 1988

Small Business and General Division M. Eisner (613) 957-2142

XXXX (the "Taxpayer") Conversion of Capital Property to Inventory

We are replying to Mr. Rynberk's memo of June 9, l988 concerning the time that two apartment buildings were converted from capital property to inventory. The problem involves the registration of the two buildings under the Condominium Act of Ontario.

The Taxpayer feels that the conversion occurred on XXXX which is the first day condominium units in the buildings were advertised for sale whereas you propose to reassess on the basis that the conversion occurred on XXXX which is the day the Taxpayer first submitted an application for the conversion of the buildings to condominiums.

The relevant facts of this situation are as follows:

(1) XXXX

(2) XXXX

(3) XXXX

(4) XXXX

(5) XXXX

(6) XXXX

(7) XXXX

(8) XXXX

(9) XXXX

Taxpayer's Position

The Taxpayer's representative has mentioned that the motivating factor for having the buildings registered as condominiums was to achieve a reduction in property taxes and that this did in fact occur in XXXX. It was only when relief under the Landlord and Tenancies Act was denied that the Taxpayer subsequently decided to sell the units as its intention to keep units as rental properties had been frustrated. Accordingly, the conversion from capital property to inventory should be regarded as occurring on XXXX, which is the first day the condominiums were advertised for sale. In relation to this view, the Taxpayer's representative has also mentioned the following points:

(a) The Conditional Approval on XXXX was granted with one of the conditions being that the Taxpayer had to obtain written intent from 25% of the existing tenants that they would be purchasing their units. The Taxpayer did not proceed with the application for several years because this condition was incompatible with its intention to retain ownership of the building for income producing purposes; and

(b) During the years of XXXX to XXXX the Taxpayer renovated the buildings to increase rental revenue. Subsequently, the buildings were rented, and by XXXX the Taxpayer had more than doubled its rental revenue.

District Office Position

Paragraph 13 of IT-218R indicates that the units in a multi-unit residential apartment will be considered to have been converted to inventory at the time when application is made to the relevant authority for approval to change the title to any such building to strata title, provided that the owner proceeds with the sale of the units. The source of this position is the Hughes case (84 DTC 6110). Because of this position, it is your view that the conversion occurred on XXXX which is the date of the application in 2 above. In connection with your view, you have also mentioned that certain actions of the Taxpayer were undertaken to maximize the value of the property. In particular, you have mentioned that the Taxpayer spent substantial sums on repairs and additions in anticipation of condominium sales and that the application for rent review relief would have enhanced the value of the condominiums if relief had been granted. In addition, the wording in the application "because of the prevailing conditions in the condominium market, we have decided to rent the apartments" also indicates that the Taxpayer intended to sell the units once they had been registered under the Condominium Act.

Rulings Position

In the above situation, the Taxpayer's representative has stated that the primary reason for converting the two buildings into condominium units was to achieve property tax reductions. While this did occur, we do not feel that this was the primary reason for having the buildings registered under the Condominium Act since the whole financial structure of the two rental properties in relation to rental income changed. In particular, the Taxpayer allowed the buildings to become vacant with the result that substantial rental income was foregone and the Taxpayer also spent significant sums on repairs and additions to prepare the units for sale. In the circumstances, it appears that the sole achievement of property tax reductions would not have resulted in the decision to have the buildings registered under the Condominium Act. It also appears that the discontinuance of the request for relief under the Landlord and Tenancies Act would not have had the effect of frustrating the intention to continue renting the property. In this regard, the Landlord and Tenancies Act limits annual rent increases to 6% unless an application for additional relief is approved. In the circumstances, it seems that even if the Taxpayer had been granted some relief, it is unlikely that it would have been a significant factor in relation to the decision of whether to keep or sell the project. This is evidenced by the fact that the request for relief was turned down in its entirety. In addition, in XXXX when the Taxpayer began to rent the buildings again, it would have been entitled to charge fair market value rent since section 128 of the Landlord and Tenancies Act provides that "where a rental unit has not been rented during the previous twelve month period, the rent then charged shall form the basis for determining whether subsequent rent increases exceed the percentage referred to in section 125" (i.e., 6%).

One other point raised by the Taxpayer's representative is that the Taxpayer did not wish to sell the units to tenants pursuant to the condition in 2(a) above as this would have been incompatible with its intention to retain the buildings for rental purposes. However, it appears to us that the Taxpayer did not wish to comply with that condition as the condominium units would have been sold in a very restricted market (i.e., the tenants) with the result that the proceeds of the sales would have been low. Another factor limiting the proceeds of sale at that time might have been that there were a large number of other units being offered for sale because there were strong rumours about an impending ban on condominium conversions in XXXX where the buildings were located.

From our review of the circumstances, it appears that the Municipality of XXXX imposed a number of onerous conditions which were supposed to act as a deterrent from having buildings registered under the Condominium Act. In response to those conditions, two possible courses of action were available to the Taxpayer. One of them was that the Taxpayer could have continued to rent the two buildings without any conditions being imposed although the Taxpayer could have proceeded to repair the buildings and make additions which presumably would have resulted in additional rental revenue. The other course of action was to proceed to have the two buildings registered under the Condominium Act. Based on our understanding of the situation, we believe that the Taxpayer intended to proceed with the latter course of action because they were willing to forego substantial sums of rental revenue, by allowing the buildings to become vacant in order to avoid condition 2(a) noted above, in anticipation of obtaining higher proceeds on the eventual sale of the condominiums. Accordingly, we agree with your view that the buildings should be regarded as having been converted to inventory on XXXX which is the date the Taxpayer submitted the application with respect to condominium registration.

As a final comment, the Department's position in paragraph 13 of IT-218R , though general in nature, supports the position set out above. However, the determination of the date when a capital property has been converted to inventory involves a question of fact.

XXXX

Original Signed By

T. Harris Chief Merchandising, Manufacturing and Construction Section Small Business and General Division Specialty Rulings Directorate Legislative and Intergovernmental Affairs Branch