Principal Issues: [TaxInterpretations translation] A taxpayer has received an amount for an option to purchase real property. What are the tax consequences of granting the option, extending it and exercising it for the holder of the real property?
Position: Reference to the consequences of the application of section 49 and reference, in the case of the exercise of the option, to the possibilities of the principal residence exemption and the capital gains deduction for qualified farm property.
Reasons: Provisions of the Act.
XXXXXXXXXX 2006-017085 Sylvie Labarre, CA December 21, 2006
Dear Sir:
Subject: Property purchase option
This is in response to your letter that you sent to XXXXXXXXXX of the XXXXXXXXXX Tax Services Office regarding the tax treatment of amounts your father received as a result of granting an option to a prospective purchaser of the farm he owned. We apologize for the delay in responding to this request.
Your father granted an option to XXXXXXXXXX Corporation to purchase his property which consists of a principal residence with a built-in garage, XXXXXXXXXX hectares of land with a small garage on it, and the farm. The farm was purchased by your father in XXXXXXXXXX and was actively farmed by him prior to June 18, 1987 for more than five years as his primary source of income. Your parents are married under a community of property regime.
The purchase option was granted for consideration of $XXXXXXXXXX in 2005 and expired on XXXXXXXXXX 2005 unless extended. On XXXXXXXXXX 2005, your father received an additional $XXXXXXXXXX for the extension of the option to XXXXXXXXXX 2006.
Your father agreed to sell his property to XXXXXXXXXX Corporation if the option was exercised. If the corporation exercised its option, the total purchase price of the property would be $XXXXXXXXXX plus the amounts received as consideration for the options and as deposits.
Some costs were incurred in the negotiations leading to those options.
Questions
Are there any amounts to be included in your parents' income for the 2005 taxation year?
Are there any amounts to be included in your parents' income for the 2006 taxation year?
Will there be any amounts to be included in your parents' return when the option is exercised?
Are your parents entitled to certain exemptions in connection with the granting of the options or the sale of the property?
What forms must be filed?
Our Comments
Under the civil law applicable to the community of property regime and pursuant to paragraph 248(22)(b) of the Income Tax Act (the "Act"), the property covered by the option is deemed to be owned by your father. As a result, your mother has no amount to include in her income for 2005 in respect of the option. If the facts remain the same in 2006, she would have nothing to include in 2006 in respect of the option.
The granting of the option and its extension in December 2005 is equivalent to a disposition of property with an adjusted cost base of nil. The amounts received by your father in 2005 ($XXXXXXXXXX and $XXXXXXXXXX) for the granting of the option and its extension will therefore be considered proceeds of disposition of the property. The expenses made or incurred to effect this disposition will reduce the proceeds of disposition when calculating the capital gain. Consequently, your father will have to calculate and include in his 2005 income the taxable capital gain resulting from that grant and extension (one-half of the excess of $XXXXXXXXXX over the outlays and expenses incurred to effect the disposition). Such a disposition will have to be reported on Schedule 3 of your father's income tax return.
According to the data you have provided for 2006, your father would have nothing to include in his 2006 income in respect of the option or its extension. However, you indicated that the parties are considering a further extension of the option. If such an extension is granted in 2006, your father will have to include the taxable capital gain resulting from that disposition. Alternatively, XXXXXXXXXX. may have exercised the option in 2006 and acquired the optioned property. If the option is exercised in 2006, subsection 49(4) may allow your father to file an amended return for 2005 to exclude from income the proceeds he received for granting and extending the option. Your father would then get a refund of the tax paid in 2005. On the other hand, your father would have to report the disposition of his property in 2006 by adding to his proceeds of disposition of $XXXXXXXXXX the amounts received for the option and its extension.
When the option is exercised, the proceeds of disposition and the adjusted cost base should be allocated between the principal residence and the other property. The adjusted cost base is the cost of the property plus or minus certain statutory adjustments. The gain calculated in respect of the residence may be reduced by the principal residence exemption. Information on the principal residence exemption is available in Interpretation Bulletin IT-120R6. This Bulletin is available on the Canada Revenue Agency (CRA) website at http://www.cra-arc.gc.ca/tax/technical/incometax/menu-e.html. Form T2091(IND) is the form used to calculate the principal residence exemption. This form can also be found on the CRA website at http://www.cra-arc.gc.ca/menu/AFAF-e.html.
Furthermore, with respect to other real property such as land that is not part of the principal residence and other buildings, your father will also have to calculate the capital gain in respect of those properties as a result of exercising the option. In addition, if your father had claimed capital cost allowance on the buildings in the past, he may have farming business income in respect of the recapture of capital cost allowance. For the capital gain on real property other than the principal residence, your father may be entitled to a capital gains deduction for qualified farm property. Based on the information you provided in the letter, the real property was used in the business of farming in Canada by your father because your father acquired the property before June 18, 1987, and used it principally in the business of farming in Canada for at least five years, during which time the real property was owned by your father. Your father will have to report the capital gain in respect of the qualified farm property in the appropriate area of Schedule 3 of the tax return and report the amount on the tax return. If he is entitled to the capital gains deduction, he should report the amount on the corresponding line in the Taxable Income section of the tax return. If your father has recapture of depreciation, he should report this amount on the farming income line in the Total Income section of the tax return.
According to your letter, you have no property other than real property. If you had other property than real property, the tax consequences would have been different. We hope you find these comments helpful. If you require any further information regarding the content of this document, please do not hesitate to contact us.
Alain Godin
for the Director
International Operations and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch