Published: March 9, 2020
Last Updated: March 17, 2020
Tax Treatment of Involuntary Dispositions – Toronto Tax Lawyer Comment
For income tax purposes the expropriation of property, or its destruction or theft, is deemed to be a disposition giving rise to a capital gain or recapture of capital cost allowance (depreciation). Our expert Toronto tax lawyers can provide tax help if your property has been expropriated or destroyed.
To the extent that a taxpayer receives the insurance proceeds on destroyed or stolen property, or expropriation proceeds from the government which is expropriating, and keeps those funds without replacing the property, then it is appropriate for tax to be paid on any capital gain or recapture. However, to the extent that the taxpayer goes out and acquires a replacement property, it would be unjust to charge tax.
Tax Free Rollover for Involuntary Disposition of Property
The Income Tax Act therefore contains a rollover provision which applies when compensation is receivable in respect of capital property that has been stolen, destroyed or expropriated. Under these circumstances, a taxpayer is permitted to defer all or a part of any capital gain arising on such disposition by purchasing a replacement property. Any excess of proceeds received, for the expropriated or destroyed property, over replacement cost will be deemed to be the gain realized, and the unrecognized portion of the gain will reduce the cost, or capital cost, of the replacement property which is acquired. In this way, liability for tax on any gain arising from the disposition or deemed disposition of the former property is deferred until the disposition of the replacement property.
For these rules to apply, the taxpayer must have received proceeds of disposition of capital property in any of the following circumstances:
- As compensation for depreciable or other capital property that has been stolen,
- As compensation for depreciable or other capital property that has been destroyed, and any amount payable under a policy of insurance in respect of the loss or destruction of such property,
- As compensation for depreciable or other capital property taken under statutory authority (expropriated) or the sale price of such property sold to a person by whom notice of an intention to take it under statutory authority was given.
Requirement for Replacement Property for Involuntary Disposition
In order to qualify for the deferral of tax rollover a replacement property must be acquired. The new property must be acquired before the end of second taxation year following the year in which the proceeds of disposition of the former property became receivable.
A particular capital property is a replacement property if:
- It was acquired by the taxpayer for the same or a similar use as the use to which the former property was put by the taxpayer or a person related to the taxpayer; or
- Where the former property was used by the taxpayer or a person related to the taxpayer for the purpose of gaining or producing income from a business, the particular property was acquired for the purpose of gaining or producing income from the same or a similar business or for use by a related person for such purpose.
The fact that the specific funds received for the former property are used to acquire another property in no way bears on the determination of whether or not the acquired property constitutes a replacement. It also follows that where a taxpayer temporarily invests such funds pending a decision on the acquisition of a replacement property, the temporary investment would normally not itself constitute the replacement.
If a taxpayer exchanges one property for another, the new property will qualify as a replacement property provided it is in fact a replacement property and the other requirements are met.
As noted above, a taxpayer effectively has 2 years to acquire a replacement property. If he does not acquire it in the year of disposition (expropriation or destruction) he will have to include the disposition on his tax return for the year. However, when a replacement property is acquired, he will be able to amend that return claiming the rollover.
If a replacement property is acquired for an amount which is greater than or equal to the insurance proceeds or proceeds of expropriation, then the effect of the rollover provision is to transfer the undepreciated capital cost (undepreciated asset cost) and the adjusted cost base for tax purposes into the new asset and to fully defer any capital gain or recapture as a result of the expropriated or destroyed asset. However, if the new asset costs less than the proceed from the old asset, then a partial capital gain or recapture will be recognized and the rest will be deferred. Proper tax planning is essential to avoid paying tax if your property has been disposed on an involuntary basis. Our top Toronto tax lawyers are available to provide you with tax help.
"This article provides information of a general nature only. It is only current at the posting date. It is not updated and it may no longer be current. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in the articles. If you have specific legal questions you should consult a lawyer."