16 March 1995 Internal T.I. 9429596 - PERSONAL USE PROPERTY

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:

How should the cost of capital additions or improvements made to personal use property that was acquired prior to V-Day be treated.

Position TAKEN:

Treat the property as having two components, the pre-V-Day component and the post V-day component such that on disposition the gain would be the aggregate of the gain calculated for each component. Alternatively, apply the provisions of ITAR 26(3) to arrive at the median amount on V-Day, and add the cost of such additions or improvements to that median amount.

Reasons FOR POSITION TAKEN:

Positions previously taken that corrected an inequitable result that would otherwise occur. This provides a similar result to that allowed for depreciable property as published in IT-217 and to that allowed in the special rule for identical properties provided under ITAR 26(8).

			March 16, 1995

	Client Assistance Directorate		HEAD OFFICE
	T1 Simplification			Rulings Directorate
B. Kerr
	Attention:  Wes Rosche	957-8953
		942959

Application of ITAR 26(3) to Personal Use Property (Cottages)

This is in reply to your memorandum of November 14, 1994, wherein you expressed your views concerning the determination of the "adjusted cost base" (the "ACB") of a cottage owned on V-Day when capital additions or improvements have been made after 1971. The term "adjusted cost base" has the meaning assigned by section 54 of the Act. The issue has arisen as a result of the comments expressed by the Technical Publications Division in a memorandum dated November 10, 1994, sent to you following their review of the draft Capital Gains Election Guide.

In your analysis you commented on the provisions of ITAR 26(3) pertaining to non-depreciable capital property and the permitted adjustments to cost provided under section 53 of the Act in the determination of the ACB of such property, and by analogy you referred to the provisions of ITAR 20(1) and the comments in IT-217 in respect of depreciable property and the response given in an earlier Hot Line Question dealing with cottages.

We agree with the comments made by the Technical Publications Division, that the legislation does not permit the proceeds of disposition to be split between the original cottage and the capital additions, nor do the additions create two separate properties since the additions would form part of the cottage.

The provisions of ITAR 26(3) apply for the purpose of computing the ACB to a taxpayer of any non-depreciable capital property that was owned by the taxpayer on December 31, 1971 and thereafter without interruption until such time as the taxpayer disposed of it. ITAR 26(3) would deem the "cost" of the property to be the median of three amounts, which amounts in the case of a cottage would generally be the actual cost to the taxpayer, the fair market value on V-Day, and the taxpayer's proceeds of disposition otherwise determined.

The term "actual cost" is defined in ITAR 26(13) to be its cost computed without reference to ITAR 26 less such portion of that cost that was deductible in computing the person's income for any taxation year ending before 1972. The term "cost" is not defined in the Act. Therefore, its ordinary meaning must be used taking into consideration generally accepted accounting principles. In our view, the capital additions would form part of that "cost", and hence included in its "actual cost", they are not adjustments referred to in section 53.

To illustrate the application of ITAR 26(3), consider a situation involving Mr. X who owns a personal use cottage that was purchased in 1965 for 20,000, had a V-Day value of 50,000 and current fair market value of 90,000. In 1980 he made capital additions of 5,000. His actual cost would be 25,000 being the price paid plus the cost of the additions. Therefore in applying ITAR 26(3) the median amount would be the V-day value resulting in a deemed cost of 50,000, which is the same as it would have been had he not made the addition. This results in a capital gain of 40,000. Hence, as you have concluded a person theoretically gets no recognition for the cost of such additions until such time as the cost exceeds the V-day value.

If we assume that the increase in value as a result of the additions is equal to the cost of additions and then compare this to another person who owned the same cottage but made no additions, that other person's capital gain would only be 35,000 (proceeds of 85,0000 less ACB of 50,000), yet each person's true economic gain is the same. If we also make a further comparison to another person who for some reason sold the property on January 2, 1972 but bought it back 2 months later for the same price, the cost of his additions would be reflected in his ACB. On the initial sale his proceeds and his ACB under ITAR 26(3) would be equal to V-Day value, such that he would have no capital gain. His cost of reacquiring the property would also equal this value, and the additions would then be added resulting in a cost of 55,000 since ITAR 26(3) would no longer apply and therefore on his later disposition for proceeds of 90,000 the capital gain would be 35,000. We agree that the results seem inequitable.

As already stated the legislation does not provide relief to this inequity. The only provision that comes close to providing any relief would be ITAR 26(4). An argument could be made that immediately before making the first capital addition, the cost of the capital property becomes relevant such that the provisions of ITAR 26(3) are applied creating a cost equal to the median amount at that time. The cost of any subsequent capital additions would be added to this cost in arriving at actual cost. However, this would not work since ITAR 26(3) would still have to applied on the eventual disposition using "actual cost" as provided for in ITAR 26(13) and this was not the intention of ITAR 26(4).

If the cottage was not a personal use property but did qualify as a depreciable property to Mr. X then the provisions of ITAR 20(1) would apply. ITAR 20(1) deems the proceeds to be his capital cost plus the amount by which the proceeds otherwise determined exceed the V-Day value. As a result his proceeds would be 65,000, his ACB would be 25,000 and his capital gain would be 40,000. This produces the same result as ITAR 26(3), which when compared to the other person's results as we did above also seems inequitable. However, the Department has provided administrative relief in paragraph 5 of IT-217 to accommodate the inequity, where it states that the actual proceeds should be apportioned reasonably between the improvements made after December 31, 1971 and the property as it was on December 31, 1971. In our situation this would result in allocating 85,000 to the cottage as it was on December 31, 1971 and 5,000 to the additions, which is also the cost of those additions. Using the example in IT-217 as a guideline we would apply the provisions of ITAR 20(1) by saying that the capital cost of the cottage on December 31, 1971 was 20,000, thereby coming up with deemed proceeds of 55,000 for the cottage as it was on December 31, 1971. As a result the total proceeds would be 60,000, the total ACB would be 25,000 and the capital gain would be 35,000. It should be noted that the position in IT-217 does not create two properties, it merely recognizes two components of that property for the purpose of applying ITAR 20(1).

Making a further comparison to identical properties, such as shares that are owned on December 31, 1971 when additional shares are acquired in 1980, the application of ITAR 26(3) would also produce an inequitable result. However, in such a case the provisions of ITAR 26(8) apply and in essence create two pools of identical properties, those acquired prior to V-day and those acquired after.

As can be seen the Department recognized the inequity in the case of depreciable property and provided administrative relief as published in IT-217. The Department of Finance also recognized the inequity in the case of identical properties and provided a special rule in ITAR 26(8), in respect of which our views are expressed in IT-78.

In a technical interpretation dated April 19, 1974, dealing with the rezoning of and partial conveyance of land, the Department stated that "...there is no specific provision in the Act for adding the cost of capital additions after 1971 to the deemed cost under ITAR 26(3) for properties owned on December 31, 1971." However, it was felt that a reasonable result would not be achieved unless the post-1971 capital additions are treated similarly to the subsection 53(1) additions. As an alternative it was suggested that "a portion of the sales price might be considered as being in respect of the part of the "property" acquired after 1971."

In the April 30, 1976, release of Hot Line Questions concerning ITAR 26(3), the following question was posed:

Section 53 has no apparent provision for adding the cost of capital additions made after 1971 to the deemed "cost" as determined under this subsection. The cost of such additions will be included or reflected in the selling price, but not the Valuation Day value or the actual cost on January 1, 1972 for purposes of ITAR 26(3), thus the "cost" will not be reasonable.

The Department's response was:

Normally one does not make "additions" to property described in this subsection, rather a taxpayer would acquire identical property and ITAR 26(8) would apply. However, if a situation should arise where an addition is made to a pre-1972 property to which this subsection applies (eg. a summer cottage), since there is no specific provision in the Act for adding the cost of such additions to the deemed cost of property as determined under this subsection, the comments in IT-217 would be applicable in determining the taxable capital gain on the disposition of the property.

In the May 31, 1985, release of Hot Line Questions concerning section 53, the following question was posed:

What is the ACB of capital property acquired before 1972 to which post-1971 additions have been made?

The Department's response was:

The post 1971 additions are not cost base adjustments; however see the comments at ITAR 26(3) question 1.

In our view each of the alternative treatments described in 1974, 1976 and 1985 produces an equitable result, and we would have no objection to the continuance of these positions. However, it would seem to be a difficult task to try and attribute the value of a property between the improvements made after December 31, 1971 and the property as it was on December 31, 1971. Accordingly, we would therefore suggest treating the post 1971 capital additions similarly to section 53 adjustments. In other words taking the median amount as at December 31, 1971 and then adding to that amount the cost of any post-1971 capital additions. Technically this would be similar to applying the provisions of ITAR 26(4) on December 31, 1971, and then ignoring the provisions of ITAR 26(3) and ITAR 26(13) on the eventual disposition of the property.

A.M. Brake
for Director
Business and General Division
Rulings Directorate
Policy and Legislation Branch