2016-0625261E5 Payment for property injuriously affected

Principal Issues: What is the tax treatment of compensation received for land that has been injuriously affected?

Position: Results in a capital gain or loss. General comments provided.

Reasons: The law.

Author: Posadovsky, Tom
Section: 54 "proceeds of disposition"; 43; 53(2)(d); 40(2)(b); 40(2)(c); 110.6(2); 110.6(1) "qualified farm and fishing property"; 44(2)

XXXXXXXXXX
                                                      2016-062526
                                                      T. Posadovsky

February 2, 2016

Dear XXXXXXXXXX,

Re:  Compensation for Land Injuriously Affected

We are writing in reply to your letter of September 29, 2015, that was forwarded to us on January 7, 2016, and your subsequent email correspondence, concerning the tax treatment of compensation for land that has been injuriously affected.  We apologize for the delay in responding.

In your correspondence, you described a situation in which a portion of XXXXXXXXXX-acres of land on which your principal residence is located was expropriated by the XXXXXXXXXX (“Ministry”).  As a result of the expropriation, the fair market value of the remaining land has been injuriously affected.  You have yet to reach a settlement, but you expect to receive a one-time lump-sum payment from the Ministry as compensation for the portion of the land that has been injuriously affected.  It is also your understanding that the compensation you will receive for the expropriated land will result in a capital gain for tax purposes; however, you wish to know how compensation for the remaining land that has been injuriously affected will be taxed under the Income Tax Act (the “Act”).

Our Comments

This technical interpretation provides general comments about the provisions of the Act (where referenced).  It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination.  The income tax treatment of a particular transaction proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R6, Advance Income Tax Rulings and Technical Interpretations.  IC 70-6R6, any guide, interpretation bulletin, or folio chapter referenced in this letter can be accessed on our website at www.cra-arc.gc.ca.Proceeds of disposition

The disposition of a capital property, or a part thereof, may result in a capital gain where a taxpayer disposes of, or is considered to have disposed of, the property for more than the total of its adjusted cost base (“ACB”) and the outlays and expenses incurred to sell or dispose of the property.  Among other things, a disposition will generally occur when there are “proceeds of disposition” (“POD”).  Typically, the POD is the sale price of property that has been sold as a consequence of a purchase and sale agreement; however, the Act also includes as POD compensation for property taken under statutory authority and “compensation for property injuriously affected … under statutory authority”.

In other words, compensation for property expropriated or injuriously affected may result in POD for tax purposes that could give rise to a capital gain (or loss).

ACB of property

Interpretation Bulletin IT-264R, Part Dispositions, and the related special release Interpretation Bulletin IT-264RSR, Part Dispositions, address the computation of a gain or loss where only part of a property is disposed of by a taxpayer.  In general, the ACB of the property owned immediately prior to the disposition must be reasonably apportioned between the part disposed of and the part retained.  However, as described in IT-264RSR, where a portion of a property is expropriated for use as a right of way, the Canada Revenue Agency will normally accept an amount equal to the proceeds from such a disposition as being the reasonable portion of the ACB of the whole property attributable to the part disposed of, provided that:

(a)   the area or the portion of the property that was expropriated or in respect of which an easement was granted is not more than 20% of the area of the total property, and

(b)   the amount of the compensation received is not more than 20% of the amount of the ACB of the property.

After the disposition of a part of the property, the ACB of the remaining property will be reduced by the amount of ACB apportioned to the part of the property sold or disposed of.

The difference between these two methods is best illustrated through an example.  Say a taxpayer has a 20-acre property with an ACB of $200,000.  One acre of the taxpayer’s property is expropriated.  Under the first method, a reasonable apportionment of the ACB (based solely on the size of the property) might be (1/20) = 5%, or $10,000.  If the amount paid for the expropriated land is $30,000, then there is a capital gain of $20,000.  The revised ACB of the remaining property is $190,000.

However, under the alternate method described in paragraph 2 of IT-264RSR, the taxpayer could allocate up to $30,000 of the $200,000 ACB to the part expropriated, effectively eliminating the immediate capital gain.  This is possible because (a) the area expropriated is less than 20% of the total property, and (b) the compensation received ($30,000) is not more than 20% of the ACB of the whole property ($200,000).  In this example, the revised ACB of the remaining property is $170,000.

Whether or not the conditions described above are met in any particular case is a question of fact and must be determined on a case by case basis.  It should also be noted that the allocation of the ACB of the total property between the two portions does not necessarily have to be on the basis of area.  Consideration should be given to any other factors which could have an effect on the relative value of either of the two portions.

Principal residence exemption

If a property or part thereof, qualifies as a taxpayer’s principal residence, an exemption can be claimed under the Act to reduce or eliminate any capital gain otherwise realized on the disposition of that property.  Income Tax Folio S1-F3-C2, Principal Residence, discusses the rules under which a property can be designated as an individual’s principal residence for a particular taxation year.

Paragraph 2.37 of S1-F3-C2 addresses the situation where property that has been injuriously affected encompasses more than just the portion eligible for the principal residence exemption.  In such a case, it is necessary to calculate the gain on the principal residence portion separately from the gain on the remaining portion of the property which does not qualify as the taxpayer’s principal residence.  Depending on the circumstances, there are some alternate methods to allocate the POD and ACB, which are outlined in paragraphs 2.37 to 2.47 of S1-F3-C2.

Capital gains deduction

We also understand that the property was once used for XXXXXXXXXX farming.  The Act provides for a capital gains deduction for up to $1,000,000 in respect of property that meets the definition of a qualified farm or fishing property (“QFFP”).  Such property includes, among other things, real or immovable property that “was used in the course of carrying on the business of farming in Canada” by, among others, an individual, a spouse, common-law partner, child or parent of the individual.  Since it appears that the property was acquired by you sometime in XXXXXXXXXX, generally speaking, a property acquired by an individual after June 17, 1987, will only be considered to have been used in the course of carrying on the business of farming in Canada if:

(a)   the property was owned by the individual or a person described above (i.e., a spouse, common-law partner, child or parent of the individual) throughout a period of at least 24 months immediately preceding the disposition; and

(b)   in at least two years during the period the property was owned by the individual or a person described above, the property was principally used in a farming business in Canada in which the individual or a person described above (referred to as the “operator”) was actively engaged on a regular and continuous basis.  Also, the operator’s gross revenue from that farming business carried on in Canada must have exceeded the operator’s income from all other sources for that two year period.

Whether your property meets the definition of QFFP is a question of fact.  These rules are fairly complex; however, more information on capital gains and the capital gains deduction is available in Chapter 2 of Guide T4037, Capital Gains – 2015 and Chapter 7 of Guide T4003, Farming Income.

While we trust that the above general information will be of assistance, all the relevant facts of any situation must be considered before the tax implications can be determined.  Often, in complex situations such as yours, it is helpful to obtain independent professional tax advice.

Yours truly,

Michael Cooke, CPA, CA
Manager
Business Income and Capital Transaction Section
Business and Employment Division
Income Tax Rulings Directorate

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