by Mark Pelcovitz
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.
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
· the property is sold to a corporation that immediately after the sale
- was controlled by the vendor, or by persons controlling the vendor, or
- where the vendor was a corporation, controlled the vendor