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: 1) Whether the demolition of a rental property results in a capital gain for income tax purposes. 2) Whether there is a conversion of property from capital to inventory resulting in a disposition at fair market value? 3) Whether the sale of the real estate assets will result in a capital gain or business income.
Position: 1) Question of Fact. In this case no. 2) No. 3) Question of Fact.
Reasons: 1) The demolition will result in a disposition of the rental property with proceeds of disposition of nil. The terminal loss on the disposition of the rental property will be limited by paragraph 13(21.1)(b) of the Act. 2) Where real estate that is used for the purpose of gaining or producing income from a business or property is converted from capital property to inventory, the act of conversion does not constitute a disposition. 3) The ultimate sale of the real estate may give rise to a gain or loss on capital account or a gain or loss on income account depending on the facts of each situation.
Luisa A. Majerus, C.A
XXXXXXXXXX (613) 957-2138
2004-008220
September 14, 2004
Dear XXXXXXXXXX:
Re: Capital Gains - Deemed Disposition
This is in reply to your letter of May 20, 2004, requesting our views on the demolition of your rental property and possible capital gains implications. Specifically, you are concerned that the demolition may trigger a deemed disposition and that the fair market value of the rental property immediately before demolition, over the cost of the rental property will result in a capital gain. You have also asked us to comment on the tax treatment of any gain should a new building be developed on the site and subsequently sold for a profit.
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. However, we are prepared to offer the following general comments.
Generally, it is our view that the demolition of a building constitutes a disposition of property in the year of demolition with nil proceeds. Therefore, if a building is demolished and there are no other assets in the capital cost allowance class to which the building belongs, a terminal loss equal to the undepreciated capital cost ("UCC") would normally result and would be deductible pursuant to subsection 20(16) of the Income Tax Act (the "Act"). However, in the case of a demolition of a building, where the land under the building is not disposed of, paragraph 13(21.1)(b) of the Act generally restricts the deduction of the terminal loss to half of the amount otherwise calculated (in your case, 1/2 of the UCC). Furthermore, paragraph 39(1)(b) of the Act provides that there is no capital loss on the disposition of depreciable property. For more information on the treatment of the disposition of a rental property please refer to our Guide, T4036 - Rental Income which can be found on our website at http://www.cra-arc.gc.ca/E/pub/.
The cost of demolition and any costs attributable to the period of the construction of the new building, such as interest paid on borrowed money used for the period of construction, must be added to the cost base of the property pursuant to subsections 18(3.1) and 18(3.2) of the Act. Please refer to Chapter 2 of T4036 - Rental Income for more information.
Once the new building is constructed and sold, any gain arising on the sale will be considered to be business income, property income or a capital gain. There is no provision in the Act that describes the circumstances in which gains from the sale of real estate are to be determined as being either income or capital. Please refer to paragraph 3 of our 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 the factors that are considered in determining if a gain is on account of income or capital.
A sale of real estate that is capital property in the vendor's hands will as a general rule, give rise to a capital gain or loss, as the case may be. However, in your situation it appears that the real estate is converted from capital property to inventory as your intention is to sell the real estate immediately after the construction of the new building.
As stated in paragraph 15 of IT-218R, where real estate that is used for the purpose of gaining or producing income from a business or property is converted from capital property to inventory, the action of conversion does not constitute a disposition as defined in the Act. However, the ultimate sale of the real estate that was so converted may give rise to a gain or loss on capital account, a gain or loss on income account or a gain or loss that is partly capital and partly income. The character of the gain or loss can only be determined on a case-by-case basis and is dependent on the facts in your particular situation. We suggest that you seek independent professional tax advice in this matter.
Also, please note that the capital gains deduction is no longer available to individuals for the disposition of real estate that is not qualified farm property. The capital gains deduction was phased out in 1994. In that year, an individual could elect to "bump up" the cost of any capital property owned at February 22, 1994 to its fair market value at that time and the capital gain recognized was sheltered by the individual's available capital gains deduction. Further information about the 1994 election can be found in Chapter 4 of our Guide T4037 - Capital Gains. Therefore, any portion of the gain on the future sale of the real estate that is capital in nature will be calculated with reference to this bumped up cost base if you made this election in 1994.
We hope these comments are helpful.
Yours truly,
John Oulton, CA
For Director
Business and Partnerships Division
Income Tax Rulings Directorate
Policy and Planning Branch
All rights reserved. Permission is granted to electronically copy and to print in hard copy for internal use only. No part of this information may be reproduced, modified, transmitted or redistributed in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, or stored in a retrieval system for any purpose other than noted above (including sales), without prior written permission of Canada Revenue Agency, Ottawa, Ontario K1A 0L5
© Her Majesty the Queen in Right of Canada, 2004
Tous droits réservés. Il est permis de copier sous forme électronique ou d'imprimer pour un usage interne seulement. Toutefois, il est interdit de reproduire, de modifier, de transmettre ou de redistributer de l'information, sous quelque forme ou par quelque moyen que ce soit, de facon électronique, méchanique, photocopies ou autre, ou par stockage dans des systèmes d'extraction ou pour tout usage autre que ceux susmentionnés (incluant pour fin commerciale), sans l'autorisation écrite préalable de l'Agence du revenu du Canada, Ottawa, Ontario K1A 0L5.
© Sa Majesté la Reine du Chef du Canada, 2004
Email this Content