Article by Jonathan Wright. Click here for homepage.
Selling a business or real estate can result in a substantial amount of tax. This burden can be particularly large if the real estate is in a rapidly-growing market like Vancouver or your business was built from scratch. Fortunately, there are some little-known rules in the Income Tax Act that can defer tax where you intend on reinvesting the proceeds of sale in a replacement property.
This update has been released in two parts. Last week’s discussed the small business rollover in section 44.1. This week we address the rollover on the sale of real estate found in section 44.
These rules apply to different types of property, but we focus here on the sale of old and purchase of new real estate.
For a purchase to qualify under the section 44 replacement property rules, the real estate sold (the “Old Property”) must meet certain requirements. There are exceptions, but generally speaking the Old Property must be a “former business property”. For this to apply, the property must be used primarily for the purpose of earning income from a business. In other words, vacant or pre-development land won’t qualify. In addition, property used in businesses earning rental income is specifically excluded.
There are also requirements for the new, replacement property. These are that it must be acquired and used by the taxpayer to replace the Old Property and for the same or similar purpose to which the taxpayer put that property.
To meet the first part of this test the property must actually be acquired as a replacement. In other words, there must be a connection between the sale and acquisition.
To meet the second part, the use for both properties must be the same. For example, if the Old Property was the clinic where you practiced psychiatry, the replacement property must fill this same role in your business.
This requirement must be satisfied within a year from December 31 of the year you sold the property. The Canada Revenue Agency and the courts have made it clear that the property must actually be used within the time period in accordance with the intended purpose. It cannot be purchased within the time period and then simply held for a later use, even if that intended use qualifies.
Please note that there are exceptions to some of these requirements for involuntary dispositions (such as government appropriation) and that, for these tests, qualifying use by related parties will satisfy the requirements.
Where the requirements above are met, the capital gain (and resulting tax) is effectively rolled from the Old Property to the replacement, avoiding tax for the time being and thereby increasing the cash that can be reinvested.
If you are looking for tax advice about this real estate rollover or other tax planning opportunities for you or your business, please do not hesitate to contact the author at firstname.lastname@example.org or 604.678.4459 to book a consultation, or visit our website at wrightlegal.ca.