9 November 2010 External T.I. 2010-0381361E5 - Sale of Land - Subsection 110.6(2)

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: Can a capital gains exemption be claimed pursuant to subsection 110.6(2) in respect the gain on the sale of land? In this case the individual who owned the land subdivided a portion of the land to be sold as a building lot. While the land was originally used for a number of years in a farming business that was subject to the rules in section 31 of the Act the land is currently rented and as such generates rental income.

Position: Question of fact but it may be possible.

Reasons: The law and previous positions.

XXXXXXXXXX
								2010-038136
								Michael Cooke, C.A.

November 9, 2010

Dear XXXXXXXXXX :

Re: Qualified farm property - capital gains exemption

We are writing in reply to your email of September 22, 2010, wherein you request our comments on the income tax implication under the Income Tax Act (the "Act") pertaining to a proposed disposition of land.

Briefly, we understand from your email, that you purchased XXXXXXXXXX acres of vacant land in XXXXXXXXXX . In XXXXXXXXXX you built a principal residence on a portion of that land which continues to be the place where you reside. We understand that the land (or at least the land excluding the portion relating to your principal residence) was farmed by you from XXXXXXXXXX until sometime in XXXXXXXXXX and since that time the land has been rented to another person who farms the land. You also indicate that farming has never been your chief source of income as you were employed on a full-time basis as a teacher. In XXXXXXXXXX , you received approval to sever a XXXXXXXXXX acre building lot from the land.

Your specific question concerns the income tax consequences relating to the ultimate sale of the building lot and, in particular, whether a capital gains deduction under subsection 110.6(2) of the Act might be claimed in respect of any capital gain that might arise from such sale.

Our Comments:

Written confirmation of the tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R5, Advance Income Tax Rulings, dated May 17, 2002. Where the particular transactions are completed the inquiry should be addressed to the relevant Tax Services Office (the "TSO"). A list of TSOs is available on the "Contact Us" page of the CRA website. Notwithstanding the forgoing, we are prepared to provide the following comments.

Whether a property is a capital property at a particular time is a question of fact which can only be determined on the basis of all the relevant facts and information at that time. The CRA's views on the type of situation described in your email are largely set out in Interpretation Bulletin IT-218R, Profit, Capital Gains and Losses from the Sale of Real Estate, Including Farmland and Inherited Land and Conversion of Real Estate from Capital Property to Inventory and Vice Versa. For instance, paragraph 10 of IT-218R provides that where real estate is used for the purpose of gaining or producing income from a business or property, its conversion to another income earning use, such as to inventory or a trading property, will not constitute a change in use and a corresponding deemed disposition and reacquisition of the real estate under the rules in the Act. However, that paragraph also notes that the proceeds of disposition from the ultimate sale of the real estate will be treated in accordance with paragraph 15 of IT-218R in such circumstances.

Paragraph 15 of IT-218R, essentially provides that where real estate is converted from capital property into inventory or trading property, the ultimate disposition of the real estate may give rise to a gain or loss that is on capital account, a gain or loss on income account or a gain or loss that is partly capital and partly income. For instance, on a conversion of capital property to inventory or trading property the increase, if any, in value of the property between the date of conversion to the date of sale will be reported in full as income while the increase, if any, in value of the property between the date the property was acquired and the date of conversion would be treated as a capital gain. The CRA's views in paragraphs 23 and 24 of IT-218R on the subdivision of farmland may also be relevant.

To the extent that a capital gain does arise on the ultimate sale of a particular property, if the particular property is a "qualified farm property" ("QFP"), which is a question of fact to be determined from an examination of all the facts, the taxpayer may be entitled to claim the capital gains deduction under subsection 110.6(2) of the Act. Subject to the possible application of subsection 69(11) of the Act, generally speaking, subsection 110.6(2) of the Act permits an individual (other than a trust) who is resident in Canada throughout the taxation year to claim a capital gains deduction of up to $375,000 (on a taxable capital gain) where that individual has disposed of QFP in that year. QFP is defined in subsection 110.6(1) of the Act and includes "real or immovable property that was used in the course of carrying on the business of farming in Canada" by certain persons, who may include the individual, the individual's spouse or common-law-partner, the individual's child or parent.

For the purposes of applying the definition of QFP in subsection 110.6(1) of the Act, subsection 110.6(1.3) of the Act provides that a particular property will not be considered to have been used in the course of carrying on the business of farming in Canada unless the "ownership test" described in paragraph 110.6(1.3)(a) of the Act is met and one of the two "farming-use tests" described in paragraph 110.6(1.3)(b) or paragraph 110.6(1.3)(c) of the Act is met.

The ownership test in paragraph 110.6(1.3)(a) of the Act requires that the particular property be owned throughout the period of at least 24 months prior to the disposition by any one or more specified persons, which include inter alia, the individual, the individual's spouse or common-law-partner, or the individual's child or parent. The determination of the applicable farming-use test will depend on when the particular property was last acquired. If the particular property was last acquired before June 18, 1987 (or after June 17, 1987 under an agreement in writing entered into before that date), the farming-use test in paragraph 110.6(1.3)(c) of the Act must be met. However, if the particular property was last acquired after June 17, 1987, the farming-use test in paragraph 110.6(1.3)(b) of the Act must be met.

While a question of fact, it appears that in your situation the land was last acquired before June 18, 1987. If that is the case, the farming-use test in paragraph 110.6(1.3)(c) of the Act would be the relevant test and that test will only be met if either:

(i) in the year the property was disposed of by the individual, the property was used principally in the course of carrying on the business of farming in Canada by the individual (or by certain other specified persons described in Clauses (A) to (E) of paragraph 110.6(1.3)(c) of the Act); or

(ii) in at least five years during which the property was owned by the individual (or by certain other specified persons described in Clauses (A) to (E) of paragraph 110.6(1.3)(c) of the Act) the property was used principally in the course of carrying on the business of farming in Canada by such persons.

It is a question of fact whether a particular farming operation constitutes a farming business at any particular time and some of the criteria which should be considered in making this determination are set out in the current version of Interpretation Bulletin IT-322, Farm Losses. Where reference is made to a property being used "principally" in the business of farming, the property will generally meet this particular requirement if more than 50% of the property's use is in the business of farming. It should be noted that while there is no requirement that the particular property be used in the business of farming immediately before the transfer by the individual disposing of the property, the property must meet the farming use test referred to above. Moreover, as noted in paragraph 14 of IT-349R3, Intergenerational Transfers of Farm Property on Death and in paragraph 25 of IT-268R4, Inter Vivos Transfer of Farm Property to Child, it is the CRA's view that the mere renting out of farmland by a lessor would not constitute the business of farming by the lessor. Accordingly, such a determination can only be made on a property-by-property basis. You may also wish to refer to Chapter 6 of the current version of the T4003 Farming Income Guide for more information on this topic.

Given all the complexities concerning the potential tax implications in your particular situation, you may wish to seek independent professional tax advice.

We trust that these comments will be of assistance.

Yours truly,

Sandy Parnanzone
Manager
For Director
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch