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: Whether a recreational vehicle park that is acquired to replace a motel, would be considered to be a replacement property for purposes of the replacement property rules.
Position: For a property to be considered a replacement property, among other things, it must be acquired for a use that is the same as or similar to the use to which the former property was put [paragraph 44(5)(a.1)]. It must also be acquired for use in a business that is the same as or similar to the business in which the former property was used [paragraph 44(5)(b)]. It is a question of fact whether an RV park is a property that can be put to a use that is the same as or similar to the use of a motel, or whether the business of operating an RV park is the same as or similar to the business of operating a motel.
Reasons: previous rulings documents
XXXXXXXXXX 2006-017318
XXXXXXXXXX
April 18, 2006
Dear XXXXXXXXXX:
Re: Replacement Property
This is in response to your letter of October 19, 2005, inquiring about whether a recreational vehicle ("RV") park qualifies as replacement property for a motel, for purposes of the replacement property rules in the Income Tax Act ("Act"). We are also replying to your letter of December 14, 2005, to your Member of Parliament, XXXXXXXXXX, a copy of which was forwarded to us from the XXXXXXXXXX Taxation Services Office. We apologize for the delay in replying.
As we understand it, you and your parents operated a motel business over the past eight years. The motel business was sold and you acquired vacant land. You are considering whether to apply for rezoning of the land for purposes of establishing an RV park there. You have asked whether the RV park would be considered to be a replacement property for purposes of the replacement property rules of the Act. It is your view that the RV park is similar to a motel business since both are in the hospitality industry and both offer similar services and amenities to clients. In addition, both businesses rent space to clients and have short and long duration visitors.
The replacement property rules in the Act permit a taxpayer to elect to defer the recognition of income or capital gains where a former property is involuntarily disposed of, or a former property that is a "former business property" (as defined in subsection 248(1) of the Act) is voluntarily disposed of, and a "replacement property" is acquired. To be considered a replacement property, the particular property must meet all the requirements outlined in the definition in subsection 44(5) of the Act. The replacement property rules are discussed in detail in Interpretation Bulletin IT-259R4, Exchange of Properties.
Based on the facts you presented, the disposition of your motel was voluntary. Accordingly, the motel must qualify as a former business property and the deadline for the acquisition of the replacement property must occur within one year of the end of the year of disposition of the motel.
Former business property is generally defined as real property or an interest therein that is used primarily for the purpose of earning income from a business and excludes a rental property that generates gross revenue that is rent. Whether the operation of a motel gives rise to business income or rental income generally revolves on the number and kinds of services provided. The Canada Revenue Agency is of the view that the operation of a motel is a business that provides services and that the revenue generated is not gross revenue that is rent. Therefore, a motel is regarded as a former business property.
A property is considered a replacement property, if it is acquired to replace the former property and there is a causal relationship between its acquisition and the disposition of the former property. In addition, the replacement property must be acquired and used for a use that is the same or similar to the use to which the former property was put (the "same or similar use test") Furthermore, if the former property was used for the purpose of gaining or producing income from a business, the replacement property must be acquired for the purpose of gaining or producing income from the same or a similar business (the "same or similar business test") Finally, a former business property cannot be replaced with a property that is a rental property.
The same or similar use test is explained in paragraphs 16 and 17 of IT-259R4. Where the former property was used for the purpose of gaining or producing income from a business, another property will usually be considered to be a property acquired for the same or similar use if it is acquired to gain or produce income from the same or a similar business and if it generally bears the same physical description as the former property. For example, a taxpayer may replace a warehouse with a manufacturing building used in the same or a similar business because both properties are buildings and the two uses are "similar" in that they are both part of the overall process of providing products from the same or similar business to the consumer. It must be kept in mind, however, that the same or similar use test, is still a separate test from, and is not overridden by, the same or similar business test. Thus, for example, if a company owned a residential property used to house its employees, a building used to carry on the company's day-to-day operations would generally not be considered as having the same or similar use even though both properties are real property and are used in the same business.
The same or similar business test is explained in paragraphs 18 to 21 of IT-259R4. A taxpayer who changes from one business category to another but continues to deal in the same product will normally be considered to be in a similar business. However, service industries, such as hotels, restaurants, tourism, and entertainment, are too varied and different to permit categorization. Where there is a question of whether two businesses in a service industry are similar businesses, the determination will have to be made on the facts of the case. For such cases, "similar business" will be interpreted in a reasonably broad manner.
It should be added that the requirements of the same or similar use and the same or similar business tests have the effective consequence that a property will not be considered a replacement property of a former business property unless it is actually used to earn income from a business by the acquisition deadline.
The application of the same or similar business test to the RV park requires ascertaining first whether it generates business income or rental income, since a rental property is not considered a replacement property for a former business property, as previously indicated. Although it is a question of fact whether a RV park generates business income or rental income, this determination generally will depend on the contractual relationship between the business owner and the client and the number and kinds of services provided. The size and number of RV pads being rented, the extent to which the management or supervision occupies the owner's time, and whether the RV pads are rented bare or provided with an electrical outlet are generally insufficient factors to conclude that the RV park does not give rise to rental income. If this were the case, the RV park would fail to be a replacement property for a motel.
However, if the operation of the RV park includes other services such as a laundromat, cafeteria, swimming pool, showers and toilets with plumbing facilities, playground, refuse disposal, security services and so on, the operation would be a business rather than a rental operation. Accordingly, in a situation in which the RV park is set up such that its operation can be regarded as generating business income, in our view, the RV park business would be considered to be similar to a motel business and therefore would satisfy the same or similar business test for purposes of the replacement property rules.
A RV park may be considered to meet the same or similar use test if it is acquired to gain or produce business income and if it generally bears the same physical description as the former property. As explained above, it is a question of fact whether a RV park generates business income or rental income, the resolution being dependent on the contractual relationship between the business owner and the client and the number and kinds of services provided. With regards to the physical description, since a motel is comprised of land and building, it would be expected that a RV park would also be comprised of land and building in order for it to qualify as a replacement property for a motel. In our view, bare land acquired for the RV park would not qualify as a replacement of the motel for purposes of the replacement property rules.
In conclusion, if the RV park you establish meets all of the requirements of the replacement property rules described above, it would be considered to be a replacement property for the motel you sold. We do not have sufficient information at this time to make a definite determination because, for example, the piece of land you acquired has not been yet developed and it is not clear which services the RV park will be offering to the public.
We trust that the foregoing information will be of assistance to you.
Yours truly,
Phil Jolie
Director
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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