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.
Principal Issues:
1. For purposes of a transfer of farm property, IT-268R4 accepts a transfer of a remainder interest as a transfer of land. Does this equally apply to a depreciable property component of the real property?
2. Does a transfer of real property under section 43.1, result in a recapture of depreciation in respect of any depreciable property component of the real property?
Position:
1. Yes
2. No
Reasons:
1. The land and buildings (fixtures) are one and the same asset
2. Section 43.1 is applicable only for capital gains purposes - XXXXXXXXXX
January 4, 1999
KITCHENER TSO HEADQUARTERS
J. P. Dunn
Attention: Shawn Gow (613) 957-2747
Business Enquiries
973197
Transfer of Life and Remainder Interest in Farm Property
Interaction of Section 43.1 and Subsection 73(3) of the Income Tax Act
We are writing in response to your memorandum regarding the above-noted subject matter and, more particularly, with reference to the hypothetical fact situation described below. We apologize for the lengthy delay in responding.
In your hypothetical situation, an individual has, since 1966, owned real property consisting of land, buildings and a residence on which a farm operation is actively carried on. In 1996, the individual transferred a remainder interest in the real property to his adult children for nominal consideration. The individual retained a life interest in the real property. You also assume that the fair market value of the properties at the date of disposition exceeds the value thereof on December 31, 1971 which, in turn, exceeded the historical cost of the properties, that the cost of depreciable properties equals the undepreciated capital cost thereof and that there have been no dispositions or acquisitions, deemed or actual, of properties since the original date of acquisition.
In order to more clearly respond to your question, we will assume that, in the first scenario below, the disposition of the remainder interest in the property fulfils the conditions in the preamble to subsection 73(3) of the Act while, in the second scenario, that the disposition does not fulfil those conditions such that subsection 43.1(1) of the Act would be applicable. Further, we are assuming that, in both scenarios, the real property under consideration consists of both a land component and a depreciable property component.
Subsection 43.1(1) of the Act deals with, inter alia, a disposition of a remainder interest in real property in which the transferor retains a life interest, but only in respect of a disposition to which the provisions of subsection 73(3) would not apply. In a situation in which the disposition of remainder interest fulfils the conditions in the preamble to subsection 73(3) of the Act, that provision would be applicable with respect to both the land component and the depreciable property component of that remainder interest in the real property to determine both the proceeds of disposition to the vendor and the cost and undepreciated cost to the purchaser of any remainder interest in depreciable property which is a component of the real property interest. An allocation of the cost of and the fair market value of the various assets being disposed of would be required between the life interest retained and the remainder interest disposed of in order to determine the various amounts pursuant to subsection 73(3) of the Act. Any capital gains or recapture of depreciation resulting from the transaction would depend upon the deemed proceeds of disposition calculated pursuant to that provision and, those deemed proceeds are dependant upon the actual proceeds of disposition. In the case in which the actual proceeds are nominal, the remainder interest in the land will be deemed, pursuant to paragraph 73(3)(b) of the Act, to be disposed of at the adjusted cost base of that property while the remainder interest in any depreciable property component of the real property will be deemed, pursuant to paragraph 73(3)(a) of the Act, to have been disposed of at the proportionate undepreciated capital cost of each of those properties. Insofar as the retained life interest is concerned, there would be no actual or deemed disposition thereof.
As you note, the adjusted cost base to the vendor of the whole property is calculated pursuant to subsection 26(3) of the Income Tax Application Rules and, as stated in paragraph 7 of Interpretation Bulletin IT-226R, the Department will accept an allocation of the adjusted cost base of a part interest based upon the relative fair market values of all interests in the property owned by the transferor.
The adjusted cost base to the purchaser of the remainder interest in the land would be determined pursuant to the provisions of subsection 26(5) of the Income Tax Application Rules which would, in the current situation, result in an cost base to the purchaser of that interest equal to the adjusted cost base of that interest to the parent.
In your analysis of this type of situation, you have noted that the remainder interest in the depreciable property component of the real property is not an “eligible” property for the purposes of subsection 73(3) of the Act as paragraph 7 of Interpretation Bulletin IT-264R4 indicates that a remainder interest in “land” can be considered as “land” for the purposes of that provision but that that position is not extended to depreciable properties. Consequently, as such properties are excluded from the application of subsection 73(3) of the Act, the disposition thereof will be subject to the provisions of subsection 43.1 of the Act.
In our view, the reference in the interpretation bulletin to a remainder interest in “land” would include both the land itself and any buildings attached thereto as it is generally understood that, if a chattel becomes fixed to land and, thus, becomes a “fixture”, that fixture becomes part of the land.
For example, paragraph 20(1)(a) of the Act permits a taxpayer to deduct such amount of the capital cost of property as is allowed by regulation and section 1100 of the Income Tax Regulations specifies the amount that is to be allowed in respect of that deduction. Subsection 1102(2) of the Income Tax Regulations states that “the class of property described in Schedule II shall be deemed not to include the land upon which a property described therein was constructed or is situated”. If not for this deeming provision, presumably the full cost of real property (land and buildings) could be included in a prescribed class for purposes of claiming capital cost allowance because it is not possible to isolate one’s interest in land from any buildings attached to it. The two components are one and the same asset.
In a situation in which the transaction does not fulfil the conditions required for the application of subsection 73(3) of the Act, subsection 43.1 of the Act will deem the life estate in the real property to be disposed of for proceeds of disposition equal to the fair market value thereof and to be reacquired immediately thereafter at that same fair market value. Also, because the parties are not dealing at arm’s length, subsection 69(1) of the Act will be applicable with respect to the disposition of the remainder interest in the real property to deem the vendor to have received proceeds of disposition equal to the fair market value of that interest. Accordingly, the net result is that the entire interest in the property will have been disposed of for proceeds of disposition equal to its fair market value.
In these circumstances the adjusted cost base of the land to the vendor immediately prior to the disposition and to the purchaser immediately subsequent to the purchase would be determined as noted above.
With respect to any depreciable properties which comprise part of the life interest, it is important to note that subsection 43.1 is applicable only for purposes of subdivision “c” of division “B” of Part I of the Act. Accordingly, while an individual may realize a capital gain in respect of any depreciable property component of the real property (because the fair market value of the life interest in the property is greater than its capital cost), there would be no recapture of depreciation because of the disposition, pursuant to subsection 43.1(1) of the Act, of the life interest in the real property. However, as the remainder interest would be considered to have been disposed of at fair market value, the proceeds of disposition for the depreciable properties would be credited to the appropriate prescribed class which could result in recapture of depreciation, depending upon the particular circumstances.
We trust that this is the information which you require.
for Director
Financial Industries Division
Income Tax Rulings and
Interpretations Directorate
3
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