Replacement Property

Under the Income Tax Act (ITA), the disposition of capital property or depreciable property generally gives rise to a capital gain or loss and a terminal loss or recapture of depreciation. But did you know that the ITA can allow the deferral, in whole or in part, of the tax consequences that arise on the disposition of such property? These are the “replacement property” rules.

These rules provide that the deferral of the capital gain and recapture may occur in the context of an “involuntary disposition” and a “voluntary disposition”. An involuntary disposition includes the following circumstances:

• Property that has been stolen and for which the taxpayer has received compensation.
• Property that has been destroyed and for which the taxpayer has received compensation under an insurance policy.
• expropriation, and
• Property sold to a person who has given notice of his intention to take it under a statute.

In the case of a voluntary disposition, it must be a disposition of a “former business property”. Former business property is capital property that is used primarily by a taxpayer to earn income from a business. It should be noted here that a rental property, i.e. a property that is used to earn income that is rent, cannot be considered a “former business property”.

Deadlines

In order to benefit from the deferral of the capital gain and the recapture of depreciation, the property that is acquired to replace the one that was disposed of, must be acquired within the following time periods:

• In the case of an involuntary disposition: generally, 2 years following the end of the year in which the disposition took place.
• In the case of a voluntary disposition: generally, 1 year after the end of the year of disposition.

Making an election

To take advantage of the replacement property rules, a taxpayer must make an election, which can take various forms:

• If the disposition and acquisition of the replacement property occur in the same year, the taxpayer's tax return calculation will be considered as the election.
• If the property is replaced in a subsequent year, the election can be made by sending a letter to the Canada Revenue Agency.
• Finally, if the replacement property is acquired before the property is disposed of, the election must also be made by means of a letter, this time sent during the year in which the replacement property is acquired.

Replacement property

For a property to be considered a replacement property, it must meet the following criteria:

• It must be a capital asset or depreciable property.
• The taxpayer must have acquired it to replace the old property.
• The replacement property is used for the same or similar purpose as the old property.
• If the former property was used to earn income from a business, the replacement property must be used in the same or a similar business.
• In the case of taxable Canadian property, the replacement property must also be taxable Canadian property.

Please refer to Income Tax Folio S3-F3-C1, Replacement Property, for more information and examples on calculating the amount of the capital gain deferral and recapture.

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