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CHAPTER EIGHT

CHAPTER EIGHT. Gains and Losses on the Disposition of Capital Property – Capital Gains I. Real Estate-special situations II. Multiple/Change in use III. Leaving/Entering Canada IV. Non-Arms Length V. Gain on Settlement of Debt VI. Death of a Taxpayer VII. Special Situations

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CHAPTER EIGHT

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  1. CHAPTER EIGHT • Gains and Losses on the Disposition of Capital Property – Capital Gains • I. Real Estate-special situations • II. Multiple/Change in use • III. Leaving/Entering Canada • IV. Non-Arms Length • V. Gain on Settlement of Debt • VI. Death of a Taxpayer • VII. Special Situations • VIII. Impact on Investment and Management Decisions Accounting 217 Spring 2005

  2. Exclusions Ch 8 • Foreign Exchange Gains/Losses • Options • Convertible Properties/Cap Gains Deferral • Certain shares deemed to be capital property • Supplemental Notes Accounting 217 Spring 2005

  3. Real Estate Used to Carry on a Business • If the replacement is voluntary and the real estate is replaced by the end of the taxation year following the year of disposition, the gain will reduce the ACB of the replacement property. This exception does not apply to real estate used to earn property income from rentals. • If the replacement is involuntary, such as expropriation, and the real estate is replaced by the end of the second taxation year following the year of disposition, the gain will reduce the ACB of the replacement property. Accounting 217 Spring 2005

  4. Voluntary/Involuntary Disposition • In the case of Recapture if replaced the recapture will be used to reduce the UCC instead of coming into income • In order to fully defer the gain/recapture you must spend at least the same amount as you received on the sale of the first property • Neither of the exceptions apply to personal use real estate. Accounting 217 Spring 2005

  5. Proceeds on Disposition of Building & Land • Effectively eliminates the terminal loss on the sale of a building with land by using the terminal loss to reduce the gain on the building. • IE Sale of Land and building for $200,000 • UCC of Building $ 75,000 or cost $90,000 • FMV Building $50,000 • Land- ACB 100,000 FMV 150,000 Accounting 217 Spring 2005

  6. Proceeds on sale of Land/Buildings • Without ITA 13(21.1) Land Buildings Proceeds $ 150,000 $ 50,000 ACB/UCC 100,000 75,000 Gain/Terminal loss 50,000 (25,000) TCG/Terminal loss 25,000 (25,000) Net effect on Income NIL Accounting 217 Spring 2005

  7. Proceeds on sale of Land/Buildings • With ITA 13(21.1) Land Building Deemed proceeds $ 125,000 $ 75,000 ACB/UCC 100,000 75,000 Gain/Terminal Loss 25,000 NIL TCG/Terminal Loss 12,500 NIL Net effect on Income 12,500 Effectively makes terminal loss ½ deductible Accounting 217 Spring 2005

  8. Property with more than 1 use • Change in use- deemed disposition at FMV • Dual use property there must be a reasonable allocation of cost/Proceeds • Change in use does not apply in changing from one income producing use to another ie business to rental • For personal use property capital gain may be deferred with an election by taxpayer • Works only on a change from personal to another use… not vice versa Accounting 217 Spring 2005

  9. Change in use and principal residence • On change in use a resident can designate the property as his principle residence for up to 4 years for purposes of the change in use rules only. Therefore change in use has not occurred. • Does not affect the claim for the principle residence exemption calculation. • Cannot take CCA during the period Accounting 217 Spring 2005

  10. Transfer of ownership to spouse • On transfer of principal residence from one spouse to another occurs.(ie Spouse A to B) • Effectively with Subsection 40(4) the years that Spouse A could designate the property as a Principal residence are transferred to Spouse B. • Spouse A cannot also use the same years. Accounting 217 Spring 2005

  11. Leaving and entering Canada • On ceasing to be a resident all capital property deemed to be sold at FMV • Exempted: Real property • Business property in permanent establishment • Canadian property that is not liquid ie stock options • Will be responsible for taxes on exempt items as a non-resident • Right to receive certain payments ie RRSP also exempt Accounting 217 Spring 2005

  12. Entering Canada • All assets deemed to be acquired at FMV at the time of entry. • Exception • Taxable Canadian Property Accounting 217 Spring 2005

  13. Non-Arm’s Length Defined • When the values placed on financial transactions are not determined by supply and demand, the parties are considered not to be dealing at arm’s length. • The Act deems parties not to be dealing with each other at arm’s length if they are related. • Non-arm’s length transactions can occur between: • An individual and another individual • An individual and a corporation • A corporation and another corporation Accounting 217 Spring 2005

  14. Non Arms Length Individuals • Transactions between individuals: • For tax purposes, individuals are related to each other if they are direct-line descendents (grandparents, parents, children, grandchildren, etc.) or if they are brothers, sisters, spouses, or in-laws. • Transactions between individuals and corporations: • An individual is related to a corporation is he/she controls the corporation, or is a member of a related group that controls the corporation, or is related to an individual who controls the corporation. • Transactions between corporations: • Two corporations are related if one corporation controls the other corporation, or if both corporations are controlled by the same person, or if one corporation is controlled by one person who is related to the person who controls the other corporation. Accounting 217 Spring 2005

  15. Related not by blood but by Fact • Even when parties are not related, it is a question of fact whether they are dealing at arm’s length for a particular transaction. • Where there is sufficient cause, CCRA can deem two unrelated parties not to be dealing at arm’s length. Accounting 217 Spring 2005

  16. Property Transferred to a Spouse or Child • Property transferred to a child, whether by gift or sale, is deemed for tax purposes to have been sold at FMV in accordance with the rules described previously. • Property sold or gifted to a spouse is deemed to have been sold and acquired at its cost amount (capital property is deemed to have been sold at its ACB and depreciable property at its UCC). • Alternatively, a taxpayer can choose to recognize a gain on a spousal transfer. Accounting 217 Spring 2005

  17. Consideration for Gift/Non Arms Length Non Arms Length Seller Purchaser Proceeds>FMV Proceeds=Act Cost =FMV Proc< FMV Proceeds=FMV Cost=amt pd Gift Proceeds=FMV Cost+FMV Accounting 217 Spring 2005

  18. Income Attribution-Spouse • Transfers or loans • If transferred with payment at FMV no issue • If interest is charged on loan at prescribed rate no issue • If low or no interest then any income or loss(including capital gains) from the property is attributed back to original spouse • Interest must be paid in year or within 30 days of Year end. Accounting 217 Spring 2005

  19. Attribution- Minors • Younger than 18 years of age • Property income subject to attribution • Capital gains is not attributed back Accounting 217 Spring 2005

  20. Gain on Settlement of Debt • An individual or a corporation may be in a position to settle an outstanding debt for less than the amount of principal owing. In effect, the debtor achieves a gain from the transaction. • When this type of gain occurs, it is not directly included in taxable income. Accounting 217 Spring 2005

  21. Gains on settlement of Debt • Instead, it is first applied to reduce any losses that have been carried over from other years, in the following order: • Non-capital losses • Farm losses • Restricted farm losses • Allowable business investment losses • Net capital losses Accounting 217 Spring 2005

  22. Gain on settlement of debt (cont) • When a taxpayer does not have any of these losses available, the gain is applied to reduce the capital cost or the ACB of the following types of assets, in any order: • Depreciable property • Capital property (non-depreciable) • Cumulative eligible capital • Certain other properties • If all of the forgiven debt is not consumed by applying it to the above items, ¾ of the remaining amount will be included in the taxpayer’s income in that year. Accounting 217 Spring 2005

  23. Death of a Taxpayer • The tax implications triggered by the death of an individual taxpayer are as follows: • Income from all sources is accrued up to the date of death. • All capital property that was owned by the deceased is deemed to have been sold at fair market value. • Representatives of the deceased (executors) are given control of the assets. After all liabilities have been satisfied, the assets are either sold or transferred to beneficiaries in accordance with the terms of a will. Accounting 217 Spring 2005

  24. Special Situations • 1994 Capital Gains Exemption Election • Deemed disposition if election filed to take advantage of $100,000 exemption • Pre 1972 CG system • 1971 Valuation day- Median Rule or V-Day Value Median or Middle of : • Actual Cost • V D Value • Proceeds of Disposition Accounting 217 Spring 2005

  25. VI. Impact on Investment and Management Decisions • The influence of the tax treatment of capital properties on investment and management decisions centres on the fact that preferential treatment is given to capital gains, regarding the amount taxable and the timing of income recognition; whereas restricted treatment is given to the utilization of capital losses. Accounting 217 Spring 2005

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