16 February 1995 Internal T.I. 9503120 - CAPITAL GAINS ELECTION

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.

MISSISSAUGA BREAKFAST SEMINAR - FEBRUARY 16, 1995

CAPITAL GAINS ELECTION

Question 1

Proposed subsection 110.6(19) allows a trust to elect to have a deemed disposition of capital property owned on February 22, 1994. This will allow the beneficiaries of the trust to take advantage of any unutilized lifetime capital gains exemption if the taxable capital gain realized by the trust can be made payable to a beneficiary pursuant to subsections 104(13) or made the subject of a preferred beneficiary election pursuant to subsection 104(14) (assuming the appropriate designation is also made under subsections 104(21) and 104(21.2))

In a situation where there are two or more capital beneficiaries of a trust and only one beneficiary has not fully utilized his or her capital gains exemption, is it possible for the trust to elect on that particular beneficiary's share of the accrued capital gain to allow the individual to utilize his or her capital gains exemption without creating taxable income in the hands of the trust or the other beneficiaries?

We would first note that the election under subsection 110.6(19) is made on a property by property basis and the elected deemed proceeds of disposition can be any amount up to the fair market value of the property on February 22, 1994. Therefore, it will be possible to restrict the deemed taxable capital gain in the trust to the amount which might be utilized by the beneficiary. However, because a deemed taxable capital gain is a nothing under trust law, in order for it to be payable to any beneficiary within the meaning of subsections 104(13) the trust indenture must specifically provide for such payments out of the capital of the trust or the powers of the trustee must be discretionary enough to allow for such payments. Therefore, if the terms of the trust so provide, it may be possible to make the deemed capital gain payable to one beneficiary only.

Alternatively, the deemed taxable gain may be made taxable to a preferred beneficiary by way of an election under subsection 104(14). However, as a general statement, this will usually result in some of the deemed taxable gain being taxed in the trust because the preferred beneficiaries' shares of accumulating income are non-discretionary (paragraph 104(15)(b)) or discretionary (paragraph 104(15)(c) and regulation 2800(1)(f)). It should be noted that all contingent preferred beneficiaries are included in the denominator of the formula in regulation 2800(1)(f) even though they cannot share in accumulating income of the trust for the year and therefore fall under paragraph 104(15)(d). In this latter circumstance some of the accumulating income would be trapped in and taxed in the trust.

Question 2

Where a housing unit is situated on land that exceeds 1/2 hectare and such excess land does not qualify as part of the principal residence, can a separate election be filed in respect of the excess land? The following numerical example is provided:

Principal Residence Excess Land Total
$ $ $
FMV on Feb. 22/94 300,000 300,000 600,000
Adjusted Cost Base (75,000) (25,000) (100,000)
Capital Gain 225,000 275,000 500,000

In the above example, how would the capital gains election be filed assuming the individual will be utilizing the full $100,000 exemption?

In the situation described above, the property owned at the end of February 22, 1994 is the housing unit and the excess land. Accordingly, the capital gains election can only be filed in respect of the entire property, which includes the excess land.

Since the principal residence is situated on the property, part of the property will qualify for the principal residence exemption. Although the excess land does not qualify as a principal residence, the accrued capital gains on the excess land, or a portion thereof, may nevertheless be sheltered from taxation by filing the capital gains election in respect of the entire property. Therefore, by using the principal residence exemption with respect to the portion of the property that qualifies as principal residence and the capital gains election with respect to the balance of the property, a good portion of the accrued capital gain on the property may be sheltered from taxation. In order to compute the portion of the accrued gain on the entire property that can be sheltered with the principal residence exemption, the portion of the total accrued capital gain that is attributable to that part of the property that qualifies as principal residence must be determined, as in the example above.

In addition, since the 1992 budget eliminated the $100,000 capital gains exemption on the disposition after February 1992 of real property, only the capital gains accrued before March 1992 are eligible for the capital gains election. Therefore, if an election is filed in respect of real property acquired prior to March 1992, by virtue of subsection 110.6(21) of the proposed legislation, the elected capital gain must be reduced by the portion of the capital gain that does not qualify for the capital gains exemption, calculated in accordance with the formula set out in the definition of "eligible real property gain" in subsection 110.6(1) of the Act.

Subsection 110.6(20) of the proposed legislation provides that the election will not be valid if the capital gains exemption claimed under the election exceeds the taxpayer's unused balance of the $100,000 capital gains exemption. However, where, as in the situation above, a portion of the accrued capital gain on the property ($225,000) can be sheltered with the principal residence exemption and the reduction for non-qualifying real property applies, the taxpayer can designate an amount for purposes of the capital gains election that triggers a capital gain exceeding his or her unused balance of the $100,000 capital gains exemption without violating subsection 110.6(20) of the proposed legislation. Since the amount claimed for purposes of the capital gains exemption is net of the principal residence exemption and the non-eligible real property gain, by triggering a capital gain that exceeds the taxpayer's unused exemption, the taxpayer can fully benefit from the unused capital gains exemption.

For instance, if the property described above had been acquired in January 1972 and the principal residence portion of the property was designated as a principal residence for all of the years that the property was owned, and also assuming that the taxpayer has not used any portion of the $100,000 capital gains exemption, the taxpayer could designate the following amount under subsection 110.6(19) of the proposed legislation:

110.6(19) elected amount $434,910
Minus: Adjusted cost base 100,000
Gain otherwise determined 334,910
Minus: Principal residence portion: 225,000
Capital gain $109,910

Eligible real property gain:

242 x $109,910 $100,000
266

Taxable capital gain (3/4) $75,000

Question 3

A rental property is owned by an individual and based on the FMV of the land and building as at February 22, 1994, there is an accrued capital gain on the land and an accrued terminal loss on the building. Where the capital gains election is utilized, does subsection 13(21.1) of the Act apply to net the terminal loss on the building against the capital gain on the land?

Subsection 13(21.1) of the Income Tax Act (the "Act") applies when a building is sold for proceeds that are less than its proportionate share of the undepreciated capital cost of its class. As indicated in paragraph 9 of Interpretation Bulletin IT-220R2, when a building is sold for proceeds that are less than its proportionate share of the undepreciated capital cost of its class, subsection 13(21.1) of the Act provides special rules to allocate proceeds of disposition between land and buildings, to restrict the potential terminal loss and possibly recapture capital cost allowances previously taken.

According to subsection 110.6(20) of the draft legislation, the election under subsection 110.6(19) of the draft legislation will only be effective if it results in an increase in the $100,000 capital gains exemption under subsection 110.6(3) of the Act, that may be claimed by the person making the election or that person's spouse. Accordingly, where the election is filed in respect of either the building alone or both the land and the building, the designated amount in respect of the building must be such that a capital gain is triggered. However, as previously noted, subsection 13(21.1) of the Act only applies where a building is disposed of for proceeds that are less than its proportionate share of the undepreciated capital cost of its class. Accordingly, if an election is filed in respect of a building or a building and the underlying land, the designated amount in respect of the building and thus, the proceeds of disposition, must exceed the building's capital cost in order for the election to be valid. If the proceeds of disposition of a building exceed its capital cost, they will necessarily exceed its proportionate share of the undepreciated capital cost of the class to which it belongs. Hence, subsection 13(21.1) of the Act will not apply where a subsection 110.6(19) election is filed in respect of a building.

In addition, since the amount designated in respect of a building for purposes of the capital gains election must exceed the building's capital cost, it is not possible to trigger a terminal loss on a building by filing the election.

Question 4

An individual owns a personal residence. The capital gains election is being utilized with respect to the residence since the property is not being designated as a principal residence for all the years of ownership. When the property is sold in the future, do the years designated as principal residence at that time have to be the same as those designated in the capital gains election?

New subparagraph 40(2)(b) of the proposed legislation, which will apply to dispositions that occur after February 22, 1994, will reduce by two amounts a taxpayer's capital gain otherwise determined with respect to the disposition of real property that was, at any time since it was last acquired by the taxpayer, the taxpayer's principal residence. In light of subsection 40(7.1) of the proposed legislation, new subparagraph 40(2)(b) will only apply where the property is, at the time of disposition, designated as a principal residence for any taxation year following the date on which the taxpayer originally acquired the property. Furthermore, as a result of subsection 40(7.1) and for purposes of subparagraph 40(2)(b), the capital gain otherwise determined is calculated without reference to the deemed disposition and reacquisition of the property resulting from an election made under subsection 110.6(19) of the proposed legislation.

The two amounts which will reduce a taxpayer's capital gain otherwise determined are the principal residence exemption, determined in the usual way, and the lesser of the reported taxable capital gain, which is the taxable capital gain that was reported when the election was filed, and the maximum taxable capital gain, which is the taxable capital gain that would have resulted from the election if the principal residence designations made in respect of the property covered by the election for years prior to 1995, regardless of whether they were made in the 1994 tax return or in a return for a subsequent year, were taken into consideration.

Therefore, if the years in respect of which a principal residence designation is made on the ultimate sale of the property differ from those used in the calculation of the gain under subsection 110.6(19) of the proposed legislation or, if no principal residence designation was made at the time the capital gains election was filed and a designation is subsequently made on the actual disposition, new paragraph 40(2)(b) of the proposed legislation will require that the gain under subsection 110.6(19) be recalculated, using the post-February 22, 1994 principal residence designation. The purpose of the recalculation is to ensure that the amount of the gain deferred in 1994 is not different than it would have been had the years ultimately designated for purposes of the principal residence exemption been used in that calculation. If the amount of the gain resulting from this recalculation is lower than the original amount calculated under subsection 110.6(19) of the proposed legislation, the lower amount will have to be used as the deduction on the ultimate sale. Consequently, whereas a taxpayer would normally deduct the original amount calculated under subsection 110.6(19) of the proposed legislation from his capital gain on the ultimate sale, where a different principal residence designation is made on the actual disposition of the principal residence, the taxpayer may be required to deduct a lesser amount. New paragraph 40(2)(b) ensures that a taxpayer does not obtain two deductions in respect of the gain accrued during a single period, as it essentially prevents a taxpayer from doubling up on the principal residence exemption and the capital gains exemption.

The November 1994 Department of Finance Explanatory Notes contain examples illustrating the impact of an election under subsection 110.6(19) in respect of a property that was for a time, the elector's principal residence. Please note, however, that two of these examples, namely, Examples C and D, are incorrect. In Example C, the figure for the recalculated gain from the deemed disposition (under (R)) should read $31,905 instead of $36,083. As regards Example D, the gain on the ultimate sale of the principal residence was calculated under the false assumption that new paragraph 40(2)(b) would not apply. However, new paragraph 40(2)(b) would apply because the property has, since it was last acquired, been designated as a principal residence. According to subsection 40(7.1) of the proposed legislation, the property was last acquired in January 1985, since the property was the taxpayer's principal residence for the 1994 taxation year. Hence, the amounts under (O) to (U) in Example D should read as follows: (O) n/a; (P) $40,000; (Q) n/a; (R) $24,000; (S) $24,000; (T) $24,000; (U) $16,000; and (V) $12,000.

Question 5

An individual owns a capital property which has an accrued capital gain in excess of $100,000 based on the FMV of the property as at February 22, 1994. However, a portion of the gain would be attributed to the individual's spouse based on the income attribution rules. Who makes the capital gains election in this scenario? What are the mechanics of making the election?

According to paragraph 110.6(19)(a) of the proposed legislation, the person who owned the property at the end of February 22, 1994 is the elector. Therefore, the person who would file the election in the situation above is the individual.

In order for an election to be valid, according to subsection 110.6(20) of the proposed legislation, it must result in an increase in the $100,000 capital gains exemption under subsection 110.6(3) of the Act that may be claimed by the person making the election or that person's spouse and it must not exceed the elector's or the elector's spouse's unused portion of the $100,000 capital gains exemption. Although an election will not be valid if the taxable capital gain resulting from the election exceeds the elector's unused $100,000 capital gains exemption, where the attribution rules apply and part of the taxable capital gain resulting from the election is attributed to a spouse of the elector, clause 110.6(20)(a)(i)(B) of the proposed legislation will not render the election ineffective even though the resulting taxable capital gain of either the elector or the spouse exceeds $100,000 and cannot be totally sheltered by his or her unused capital gains exemption.

For example, if a $200,000 taxable capital gain is triggered as a result of the election and the attribution rules apply to attribute 60% of the gain to the elector and 40% to the spouse, resulting in a taxable capital gain of $120,000 for the elector and $80,000 for the spouse, the election will not be invalid, notwithstanding that it results, for the elector, in a taxable capital gain that exceeds $100,000. In this situation, the elector would be taxable on the difference between the taxable capital gain generated by the election and his or her unused portion of the $100,000 capital gains exemption. For that reason, the elector and the spouse may considerer triggering a taxable capital gain that will not cause either one to be taxable. For instance, if the taxable capital gain triggered by the election were $165,000, instead of $200,000, a smaller portion of the accrued gain on the property would be sheltered with the capital gains exemption, however, neither the elector, nor the spouse, would be taxable on the gain triggered by the election.

On the other hand, where elections are filed in respect of property that is jointly owned by spouses, the gains from the disposition of which are attributed to only one spouse, the election of the spouse who does not report any part of the taxable capital gain will only be valid if it does not cause the other spouse to exceed his or her unused $100,000 capital gains exemption limit. For example, if elections are filed in respect of a property that is jointly owned by two spouses (A and B), the taxable capital gain on the property is $130,000, such that each spouse files an election to report a $65,000 taxable capital gain, and the attribution rules apply to attribute A's taxable capital gain to B, A's election will not be valid since it would result in B exceeding his or her capital gains exemption limit of $100,000. If B has not used up any part of his $100,000 capital gains exemption, in order to fully utilize the exemption and avoid A's election being invalid, A should designate an amount in the election that triggers a taxable capital gain of $35,000, instead of the full gain of $65,000.

Question 6

Can the expenditures incurred in respect of the valuation of a property for purposes of the capital gains election be deducted or added to the adjusted cost base of the property?

Although paragraph 53(1)(n) of the Income Tax Act (the "Act") allows a taxpayer to add to the adjusted cost base of property, the reasonable costs incurred in valuing the property for purposes of its disposition, this provision is not considered to apply to deemed dispositions which arise by virtue of the Act. In our opinion, the costs incurred in valuing property for purposes of a deemed disposition cannot reasonably be considered to have been incurred to facilitate the disposition. Their sole purpose is to facilitate the determination of the proceeds of disposition of property, as a factor in computing the capital gain on the property. In addition, although paragraph 40(1)(a) of the Act provides for the deduction, in the computation of a taxpayer's gain from the disposition of property, of any outlays and expenses made for the purpose of making the disposition, it is our opinion, based on the above comments, that valuation costs incurred for purposes of filing the capital gains election would not qualify under paragraph 40(1)(a) of the Act.