If real estate is sold and a portion of
the proceeds is not due until after the end of the taxation
year, a portion of the gain may be deferred for income
tax purposes. These “reserves” are available
to all taxpayers (i.e. individuals, corporations, etc.)
on the sale of both capital property and inventory. This
article will deal only with capital gains reserves.
The Income Tax Act does not contain a formula
to compute the reserve other than to limit it to 80% of
the gain in the year of the sale, and 60%, 40%, and 20%
in the next three years. However, over the years, the
following formula has become accepted.
Reserve =
Amount receivable x Capital gain
Proceeds – Mortgage assumed by purchaser
It will readily be seen by inserting numbers
into this formula that, subject to the 80%, 60%, etc.
Limitation, the vendor can claim a greater reserve if
the purchaser assumes a mortgage on the property rather
than if the vendor discharges the mortgage prior to the
sale. However, the CCRA (formerly Revenue Canada) will
allow the denominator in the formula to be reduced by
the mortgage assumed only if the mortgage financed the
acquisition of the land or improvements to it. In other
words, the CCRA will not accept an increased reserve which
arises because a mortgage is placed on the property, for
example, in anticipation of its sale.
The reserve is available even if the debt taken back on
the sale is assigned as security for other debt.
The maximum reserve need not be claimed,
the reserve cannot be increased in a subsequent year.
The reserve ceases in the year in which
the debt is collected. In any event, the reserve is not
available after four years; i.e. the gain must be recognized
in full in the fourth year after the sale even if the
debt has not been collected by then.
It is important to note that recaptured
depreciation must be included in income in full in the
year of the sale even if a portion of the sale proceeds
is not due until after the end of the year.
The reserve is either not available or ceases
to be available if
· the vendor is an individual who
dies during the year (unless the amount receivable is
bequeathed to a spouse or spouse trust in which case the
spouse or spouse trust will step into the shoes of the
vendor
· the vendor is not a resident of
Canada or is exempt from tax at the end of the year in
which the reserve would otherwise have been available
· the vendor ceases to be a resident
of Canada or is exempt from tax at any time in the year
immediately following the year in which the reserve would
otherwise be available
