The Income Tax Act provides a number of replacement property rules for capital property that are meant to address the business realities of having to replace property due to voluntary disposition and involuntary disposition (fire, natural disasters, theft, expropriation, etc). These rules allow for a deferral of capital gains or recapture on the disposition of property when you meet certain conditions.
This article deals with the replacement property rules related to involuntary dispositions. There are rules that have to be met for the “old property” (the one disposed) as well as those for the “replacement property”. Where the rules are met, you get to defer paying tax on gains or recapture and invest the proceeds of sale into a replacement property.
The “old property” must be a “former business property”, meaning that the property must have been used primarily for the purpose of gaining or producing income from a business. In other words, the property has to be something that your business uses (more than 90% of the use of the property) to earn income from the business. This is usually the easy part.
The “replacement property” must be acquired AND used by the taxpayer to replace the “old property”, and the use must be for the same or similar purpose as the old property. There has to be some sort of a connection between the disposition and the new acquisition. The “replacement property” has to in fact be acquired as a replacement for the “old property”. The “replacement property” has to also serve the same purpose in your business, or a sufficiently similar purpose, as the “old property”. These requirements have to be satisfied within a year from the calendar year end (December 31) of the year that the property was disposed and must actually be used within that time period for the intended purpose. It cannot be purchased and held for some later use.
The CRA sets out the rules in these terms:
- The property was purchased to replace the former property.
- The property was purchased for a similar purpose as the former property was being used for.
- The property was purchased to gain or produce income from the same, or a similar business as the former property.
- If the replacement was involuntary, the purchase must occur within two years from the end of the year the insurance proceeds became available (receivable) or other funds related to the disposition became available (receivable).
There are a few exceptions, but the above are the general rules. To get this deferral, you have to file an election with the tax return in the year that the replacement property was purchased.
