Polonovski – Court of Quebec prefers IT-218R over CAE

Two individuals acquired a rental property, consisting of a duplex and triplex, in 2004. In 2009, they decided to enlarge the duplex and convert it to an open-plan single-unit dwelling. After receiving the required approval from the City of Montreal in April, 2010, a declaration of co-ownership was registered, permitting the effective severance (pursuant to a co-ownership, or “indivision,” agreement) of the triplex and the former duplex, which was sold the next year following its renovation.

Quenneville JCQ found that, in light of the taxpayers’ other increased real estate activity at the around the same time, and in contrast to Latulippe, the application for division of the property evinced a conversion of the property from capital property to inventory.

In assessing the gain on the renovated unit, the ARQ had applied the methodology in IT-218R, para. 15, which was to calculate a notional capital gain at the time of seeking approval from the City for the division, based on the estimated FMV of the duplex at that time, and treating the excess of the gain in 2011 over that capital gain as being a business property. However, consistently with IT-218R, the resulting taxable capital gain was not recognized until the year of the actual sale in 2011. In the course of rejecting the taxpayers’ submission that the CAE decision should instead be applied to treat the taxable capital gain as only being includible in the taxpayers’ income in 2010, Quenneville JCQ stated:

It can be seen that this argument is attractive to the plaintiffs, allowing them to argue that the capital gain should have been taxed in 2010 and to argue that this is a statute-barred year. However, in all other cases, mainly where the sale of the property occurs years later, the taxpayer would be at a distinct disadvantage in the scenario proposed by the plaintiffs.

Neal Armstrong. Summary of Polonovski v. Agence du revenu du Québec, 2020 QCCQ 8943 under s. 9 – capital gain v. profit – real estate, computation of profit.