2024-1014761E5 Replacement property rules

Principal Issues: Does a vacant rental property qualify as a "former business property" for the purposes of the replacement property rules?

Position: No.

Reasons: In general, a vacant or unused property is not considered to be used by a taxpayer primarily for the purpose of producing income from a business and in the event the property had been rented, a rental property is expressly excluded from the "former business property" definition found at subsection 248(1).

Author: Jacques-Mignault, Rachel
Section: 44(1), 248(1)

XXXXXXXXXX

2024-101476
R. Jacques-Mignault

July 26, 2024


Dear XXXXXXXXXX:

Re: Replacement Property Rules

This is in reply to your letter sent to the Income Tax Rulings Directorate, which we received on April 18, 2024.

You have requested confirmation that the replacement property rules under section 44 of the Income Tax Act (“Act”) would apply to defer the capital gain realized upon the sale of a real estate property. Specifically, you said that you intend to sell a real estate property owned by XXXXXXXXXX. due to XXXXXXXXXX, which has made it impossible to rent out the property.

Our comments

This technical interpretation provides general comments about the provisions of the Act and related legislation (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 particular transactions 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 70-6R12, Advance Income Tax Rulings and Technical Interpretations.

In general, where a capital property, other than a share of the capital stock of a corporation, is disposed of, whether voluntarily or involuntarily, and a replacement property is acquired within specified time limits, subsection 44(1) may provide for the deferral of all or part of the capital gain on the disposition. Similarly, subject to various requirements, all or part of the recapture of capital cost allowance on the disposition of a property that is depreciable property of a prescribed class may be deferred by virtue of subsection 13(4) where a replacement property is acquired within the specified time limits. The rules are generally referred to as the replacement property rules.

Paragraph 1.3 of Folio S3-F3-C1 – Replacement property (“Folio S3-F3-C1”) describes that, a former property, for the purpose of the replacement property rules is a property disposed of in either of the following situations:

“• when subject of an involuntary disposition: a property where the proceeds of disposition (POD) received by the taxpayer consist of compensation for property unlawfully taken (for example, stolen), compensation for property destroyed including any amount of insurance proceeds payable in respect of that loss or destruction, compensation for property taken under statutory authority (for example, expropriated) or the sale price of property sold to a person by whom notice of an intention to take it under statutory authority was given.; or

• when subject of a voluntary disposition: a property that was, immediately before the disposition, a “former business property” of the taxpayer.”

Therefore, when a property is the subject of a voluntary disposition, the property must qualify immediately before its disposition as a “former business property” of a taxpayer. The term “former business property” is defined at subsection 248(1) of the Act and paragraphs 1.27 and 1.28 of Folio S3-F3-C1 provide further comments on this definition.

In general terms, a former business property is defined as meaning real or immovable property, an interest in a real property a or right in immovable property. The property must be used by the taxpayer primarily for the purpose of gaining or producing income from a business and generally excludes a rental property.

For the replacement property rules to apply to former business property, paragraph 44(1)(b) of the Act requires that it qualify as such immediately before its disposition. This means that the words “used…primarily” in the definition of former business property refer to the use made of the property during the tax year of disposition. Accordingly, the property must have been used primarily to earn income from a business (not rent) during the year of disposition. Where no use was made of the property during that year, the use made of the property in the previous tax year will be considered.

We are generally of the view that vacant or unused rental property is not “used” by a taxpayer primarily to earn income from business during the year of disposition and as such, does not qualify as a former business property of a taxpayer.

In addition, and as noted, the definition of former business property found in subsection 248(1) of the Act expressly excludes rental property. Specifically, paragraph 1.29 of Folio S3-F3-C1 states:

“The definition of former business property excludes rental property. For purposes of this definition, rental property is defined to mean real or immovable property owned by the taxpayer and used in the particular year principally for the purpose of gaining or producing gross revenue that is rent. Accordingly, even though a property is used to earn qualified business income, it would be disqualified as a former business property if, in the tax year of disposition, it was used principally for the purpose of producing rent. However, if a property is leased by the taxpayer to a person related to the taxpayer and is used by that related person principally for any purpose other than gaining or producing gross revenue that is rent, it is not included in the definition of rental property.”

In summary, among other requirements, a property that is disposed of voluntarily must be a former business property for the replacement property rules to apply. Property that is used primarily to earn rent (other than to a related party who uses it for a purpose other than to earn rent) or is vacant but would otherwise earn rent, would not qualify.

We trust our comments will be of assistance.

Yours truly,



Pamela Burnley
Manager
Business and Capital Transactions Section
Business and Employment Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

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