30 January 1995 External T.I. 9421615 - DISPOSITION OF REAL ESTATE

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

		942161
XXXXXXXXXX	B. Kerr

Attention: XXXXXXXXXX

January 30, 1995

Dear Sirs:

Re: Disposition of Land and Building

This is in response to your letter of August 11, 1994, wherein you requested our opinion concerning the disposition of land and building. You have requested our views as to what the date of disposition of a property is when the closing date has been delayed. You have also requested our views on the tax treatment of a demolished building that was situated on a parcel of land purchased with the intention of tearing down the building and then developing the land by subdividing it and constructing homes or selling the lots. However, due to rezoning delays, the building continued to be used and run as a squash club for five years by the purchaser prior to being torn down. We apologize for the delay in our response.

Our Comments

In your letter you have outlined what appears to be an actual fact situation related to a past transaction. The review of such transactions falls within the responsibility of the District Taxation Offices and it is the practice of this Department not to comment on such transactions when the identities of the taxpayers are not known. However, we can provide the following general comments.

The Department's views on the sale of property are contained in Interpretation Bulletin IT-170R. As stated therein, when the words in the definition of "disposition" are read in conjunction with the definition of "proceeds of disposition" in section 54, it is evident that the date of disposition of capital property sold occurs at the time that the vendor is "entitled to...the sale price." In this manner the date of disposition is given a somewhat restricted meaning when a disposition of capital property involves a sale.

Where property is sold, paragraph 12(1)(b) requires an amount to be included in the computation of a taxpayer's income from a business at the time that the amount becomes receivable by the taxpayer. Since the amount that becomes receivable in respect of property sold is the sale price, the taxable event under paragraph 12(1)(b) can be stated as occurring on the date the sale price becomes receivable to the vendor.

It is the Department's view that the sale price of any property sold is brought into account for income tax purposes when the vendor has an absolute but not necessarily immediate right to be paid. As long as a condition precedent remains unsatisfied, a vendor does not have an absolute right to be paid.

Paragraph 54(e) of the definition of "disposition" makes it clear that for purposes of subdivision c of Division B of Part I, the Act is interested only in dispositions that involve a change in beneficial ownership. This is also the Department's view in respect of dispositions of depreciable property described in subsection 13(21) and the sale of trading assets under paragraph 12(1)(b).

Since possession, use and risk are the primary attributes of beneficial ownership, registration of legal title alone is of little significance in determining the date of disposition. Factors that are strong indicators of the passing of ownership include: physical or constructive receipt, entitlement to income from the property, assumption of responsibility for insurance coverage, and commencement of liability for interest on purchaser's debt that forms part of the sale price.

In the case of sales of real property, a purchaser acquires an equitable interest in the property upon execution of a binding agreement for sale or an accepted offer to purchase. Although it may be correct to say that the property has been sold at that time, there is not necessarily a disposition at that time for the purposes of subsection 13(21) and section 54 because of the restricted meaning given is respect of a disposition that involves a sale. It is equally clear that a vendor will not necessarily have an amount receivable under paragraph 12(1)(b) at that time. There will be no effect for income tax purposes unless and until the vendor becomes entitled to the sale price.

Many agreements involving the sale of real property propose a closing date for the completion of the sale. This is normally the date that beneficial ownership is intended to pass from the vendor to the purchaser and the time the vendor is entitled to the sale price but the facts of a particular situation must support that the expressed intent was in fact carried out. In cases where the closing date is to occur on or before a specified date, the actual date of closing must be determined by the particular facts such as: the date funds required to be paid on closing were actually paid, the date the title was conveyed, the date of adjustments of insurance premiums, rentals, mortgage interest, realty taxes etc., and the date of possession by the purchaser.

Given the above comments, in our view, it appears that the disposition for tax purposes of the property for which the closing date has been delayed would not occur until the condition precedent was satisfied and final closing took place.

The classes of property described in Part XI of the Regulations and in Schedule II in respect of which capital cost allowances are deductible under paragraph 20(1)(a) or terminal losses are deductible under subsection 20(16) do not include property that is described in a taxpayer's inventory or property that was not acquired for the purpose of gaining or producing income by virtue of Regulation 1102(1). As stated in paragraph 6 of Interpretation Bulletin IT-128R, where a taxpayer purchases real estate including a building and the building is torn down within a relatively short time after purchase, the question arises as to whether the building should be classed as depreciable property. If the building is demolished by the purchaser without having been used to earn income, the building cannot be regarded as depreciable property. Also, where the building is used to earn income for only a short period prior to demolition, it is not regarded as depreciable property unless the taxpayer can clearly establish that the prime intention on acquiring the building was for the purpose of gaining or producing income. The Department's position with respect to the costs of demolishing a building incidentally acquired on obtaining a site is discussed in Interpretation Bulletin IT-485.

Paragraph 6 of IT-485 states that in some cases a taxpayer may buy a piece of real estate including a building with the intention of tearing down the building. Where the taxpayer has not used the building to earn income, it would seem clear that the purchase price was paid for the land and might even have been greater if the building had not been on it. In these circumstances, the cost of demolishing the existing structure, less any amount of salvage, will form part of the cost of the land. Paragraph 7 of Interpretation Bulletin IT-220R2 also provides additional comments on allocating the purchase price between land and buildings. In the event that a portion of the cost can be allocated to the building, the subsequent demolition of the building would constitute a disposition and may result in a capital loss in the purchaser's hands.

Paragraph 8 of IT-220R2 states that where the buildings are not demolished shortly after the purchase, the facts of each case will determine whether any part of the price was in respect of those buildings and whether the property was depreciable property, taking into consideration such factors as: the length of time prior to demolition and whether the building was income producing, repairs and maintenance to the buildings, amount of income earned, renewal of leases, if any, and the length of renewal, and costs of breaking leases, if any.

The Department's views on the treatment of profits, capital gains and losses from the sale of real estate and conversion of real estate from inventory to capital and vice versa are contained in paragraphs 20-22 of Interpretation Bulletin IT-218R.

Where a taxpayer acquires real estate and allocates its cost to inventory in the taxpayer's accounting records, such accounting treatment will be considered prima facie evidence that the real estate was initially acquired with the intension of reselling it at a profit at a propitious time. If such real estate is vacant land, it is the Department's position that any gain on its sale, as such, will be business income rather than a capital gain.

A taxpayer who constructs buildings for sale and who originally intended to sell a particular building soon after it was converted may, however, permanently convert that building from inventory to capital property by;

(a)establishing that the original intention to sell the building has been abandoned,

(b)capitalizing the cost of the building and the cost of the lot upon which it sits, in the financial records, and

(c)by making use of the building as a capital asset for a period of time in a manner that is more indicative of investing than trading. Examples of such uses are as follows:

(i) the rental of the building on a long-term lease which does not provide the lessee with an option to purchase,

(ii) the housing of the taxpayer's business, or

(iii) the rental of part of the building on terms described in (i) and the occupation of the remainder thereof by the taxpayer for the purpose described in (ii).

These same considerations will apply with respect to real estate, other than vacant land, that was purchased for the purpose of resale.

A taxpayer who constructs buildings for sale will not be considered to have converted inventory to capital property when part or all of any such building is temporarily rented for any reason. Rental revenues so received, net of expense, will be included in computing the taxpayer's income, but since the building will, at all times, be considered to be held as inventory, it will not be eligible for capital cost allowance.

In the event, that a building is considered to be a depreciable property, its disposition may also be subject to the rules in subsection 13(21.1) of the Act. Briefly, when the proceeds of disposition for a building are less than its proportionate share of the undepreciated capital cost of its class, subsection 13(21.1) provides special rules to allocate proceeds between land and buildings, to restrict the potential terminal loss and possibly recapture capital cost allowance previously taken.

The rule under paragraph 13(21.1)(a) applies where both the disposition of the building and the "land subjacent to, or immediately contiguous to and necessary for the use of the building" (the "related land") takes place in the same taxation year. Where the land area disposed of exceeds that necessary for the use of the building, paragraph 13(21.1)(a) is considered to apply only in respect of the portion that is necessary for the use of the building. In such cases, a reasonable allocation of the total proceeds and the total cost for tax purposes of the land between the necessary and the superfluous portions of the land is required. Where the related land is not disposed of in the same taxation year as the building but was owned at any time before the disposition of the building by the taxpayer or by a person with whom the taxpayer was not dealing at arm's length, paragraph 13(21.1)(b) provides a different rule. IT-220R2 provides additional comments on how these rules work.

Given the above comments, in our view, in a situation where a building is acquired with the intention of demolishing is actively used in a business for five years prior to demolition its likely that the building would be depreciable capital property. However, all the facts and circumstances must be examined in resolving this question of fact. Such an examination should be conducted by officials of your local Tax Services Office, with whom you may wish to review the matter in greater detail.

As stated in paragraph 21 of Information Circular 70-6R2 dated September 28, 1990, the opinions expressed in this letter are not rulings and are consequently not binding on the Department.

We trust that these comments will be of assistance.

Yours truly,

R. Albert
for Director
Business and General Division
Rulings Directorate
Policy and Legislation Branch