Principal Issues: Whether a voluntary disposition of a particular property can benefit from the replacement property rules as a "former business property" (defined in subsection 248(1)).
Position: It is a question of fact which depends on the circumstances.
Reasons: A rental property used by a taxpayer principally for the purpose of gaining or producing gross revenue that is rent does not qualify.
XXXXXXXXXX 2010-038888 Kathryn McCarthy, CA (613) 828-9377 February 8, 2011
Dear XXXXXXXXXX :
Re: Replacement Property
This is in response to your e-mails of December 1, 2010, and January 18, 2011, and further to our telephone conversations on January 6 and 10, 2011 (McCarthy/XXXXXXXXXX ), concerning the above noted subject.
You described a client which is a corporation that owned a property (i.e. land and building) that was used to earn monthly rental income. Approximately 55% of the total gross rental revenue received was from the rental of two commercial units on the first floor of the building. The size of one commercial unit was 4,800 square feet, and the other was 4,500 square feet.
The remaining gross rent was received from a Provincial Welfare Authority for the rental of 25 separate rooming units with an approximate total square footage of 18,000 on the second and third floors of the building. Fresh linen was supplied to tenants of the rooming units when they first moved in and their stay typically lasted between one and six months. The annual occupancy rate was between 65 - 80% in the rooming units.
The property was run by one full-time employee who is also the sole shareholder of the corporation. There was no security guard on the premises, however security cameras were used. The parking space did not generate any revenue.
The corporation voluntarily disposed of the property and realized a capital gain. Consequently, you have enquired whether the property is eligible for the replacement property rules on the basis that it qualifies as a "former business property" as defined in subsection 248(1) of the Income Tax Act ("the Act").
Our Comments
The situation outlined in your letter appears to relate to a factual one, involving a specific taxpayer. It is not this Directorate's practice to comment on proposed transactions involving specific taxpayers other than in the form of an advance income tax ruling. For more information about how to obtain a ruling, please refer to Information Circular IC 70-6R5, Advanced Income Tax Rulings, dated May 17, 2002. This IC and other Canada Revenue Agency ("CRA") publications can be accessed on the Internet at www.cra-arc.gc.ca. Should the situation involve a specific taxpayer and a transaction that has already been completed, you should submit all relevant facts and documentation to the appropriate Tax Services Office ("TSO") for their views. A list of TSOs is available on the "Contact Us" page of the CRA website. However, we are prepared to provide the following general comments, which may be of assistance.
Generally, the replacement property rules in subsections 13(4) and 44(1) of the Act permit a taxpayer to elect to defer the recognition of income or capital gains where a former property that is a "former business property" is voluntarily disposed of, and a "replacement property" is acquired. Whether or not a particular property can be considered a former business property is a question of fact. For more information regarding the meaning of former business property and the replacement property rules, please refer to Interpretation Bulletins IT-491, Former Business Property, and IT-259R4, Exchange of Property, which are available on the Internet on the CRA website.
Subsection 248(1) of the Act (as proposed to be amended) defines "former business property" in respect of a taxpayer to mean:
"...a capital property of the taxpayer that was used by the taxpayer or a person related to the taxpayer primarily for the purpose of gaining or producing income from a business, and that was real or immovable property of the taxpayer, an interest of the taxpayer in real property, a right of the taxpayer in an immovable or a property that is the subject of a valid election under subsection 13(4.2), but does not include:
a) a rental property of the taxpayer,
b) land subjacent to a rental property of the taxpayer, or
c) land contiguous to land referred to in paragraph (b) that is a parking area, driveway, yard or garden or that is otherwise necessary for the use of the rental property referred to therein, or
d) a leasehold interest in any property described in paragraphs (a) to (c)..."
Generally, "rental property" is real or immovable property owned by the taxpayer and used in the taxation year principally for the purpose of gaining or producing gross revenue that is rent. Accordingly, a property would be disqualified as a former business property if it was used in the taxation year in which it was disposed of principally for the purpose of producing rent. However, "rental property" does not include a property leased by the taxpayer to a person related to the taxpayer and used by that related person principally for any purpose other than gaining or producing gross revenue that is rent.
The renting of real property is generally not, in and of itself, a business. Generally, whether or not it is a business depends on the number and kinds of services supplied and not on the size or number of properties being rented. The type of services to be examined would usually not include the maintenance of the building or, in the case of a building rented piecemeal (e.g. an apartment block), basic services which, by custom, have come to be regarded as an inherent part of that kind of property rental (e.g., heat, water, elevator service, a telephone in the lobby, indoor or outdoor parking spaces, a laundry room equipped for tenants, snow and garbage removal service, and the maintenance of any appliances provided in the rented accommodation). For further information on how to determine whether the rental of a particular property may be regarded as a business by the CRA, please consult paragraphs 4 - 7 of Interpretation Bulletins IT-434R, Rental of Real Property by Individual, and IT-434SR, Rental of Real Property by Individual, which are available at www.cra-arc.gc.ca/menu/ITSC_400-e.html.
If it is found that a building is not used by the taxpayer or a person related to the taxpayer primarily for the purpose of gaining or producing income from a business, it would not qualify as a former business property and the replacement property rules in subsections 13(4) and 44(1) of the Act would not be applicable on a voluntary disposition of the building.
We trust the foregoing comments are of assistance.
Yours truly,
S. Parnanzone
Manager
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch