Replacement Properties: COVID Time Not Counted

Danielle Doan and Evelyn Jacks

As the final quarter of 2023 is just around the corner, many taxpayers will want to discuss year end tax planning; specifically, what can be done to reduce cash flow required to settle tax debts triggered by 2023 transactions. Thanks to proposed legislative amendments released August 4, 2023, there’s a little known nugget for investors.  It’s possible to recoup prior year tax dollars on capital gains if a replacement property was acquired, and get a pandemic-related reprieve.  Here’s how it works:

A quick review of the taxpayer’s annual corporate tax return schedule 6, or personal income tax schedule 3 will identify any capital gains reported. Look for an opportunity to defer the gain from immoveable capital property (other than shares), reported from the following incidents:

• The capital property was unlawfully taken;
• The capital property was destroyed and the proceeds are from insurance;
• The capital property was taken or sold under a statutory authority (expropriation); or
• The capital property was a former business property (real property) of the taxpayer.

Currently, under subsection 44(1), the taxpayer can defer the capital gain if they so elect on their tax returns, and then replace the property within a certain time period. The require time periods are;

• 24 months after the year of disposition for involuntary disposition and,
• 12 months after the year of disposition for voluntary disposition.

Once passed, the proposed legislation released August 4, 2023 will be effective March 15, 2020.  New subsection 44(1.01) would be added below subsection 44(1), to bring Covid relief to the calculations of the required replacement time period.  Taxpayers will be able to exclude the time between March 15, 2020 and March 12, 2022. This means Covid time does not count.

In the year of the disposition, the election will entitle the taxpayer to defer a portion of the income that would have been subject to taxation as a result of the disposition. The amount taxed in the year of disposition is the lesser of;

• the actual income or gain on the disposition and,
• the amount of proceeds in excess of the cost of the replacement property.

The amount that is not taxed is treated as a reduction of the tax cost of the replacement property, so that the taxation of this amount is deferred until such time as the replacement property itself is disposed of.

Let’s walk through an example.  The taxpayer has lost a building due to a fire.

• The building had an original cost of $200,000 (no CCA taken).
• The insurance on this building provided a payment of $300,000.
• The taxpayer was able to build a new building in the same year as the fire for $375,000.
• However, it’s important to note, due to new proposed subsection 44(1.01), the 12 months in this replacement period calculation do not need to include any months between March 15, 2020 and March 12, 2022.
• The gain on the building would normally be $100,000, however as long as the taxpayer elects to use the replacement property rules, since the taxpayer paid more than the proceeds to replace the property, the taxpayer has no gain resulting from the disposition.
• The cost of the new building to the taxpayer is $375,000 - $100,000 or $275,000.

Continued careful planning surrounding the timing of replacing property that has been unlawfully taken, destroyed, expropriated, or sold must be performed if the taxpayer intends to use the replacement property rules to defer the capital gain.

However, in addition, prior transactions should be reviewed in light of the proposed amendments to subsection 44(1.01) to exclude the months between March 15, 2020 and March 12, 2022 when calculating the required replacement time period, to ensure beneficial tax deferrals are utilized.

Make a Difference.  Personal and corporate income tax specialists who sharpen their knowledge to little-known tax nuggets can really make a difference in cash flow management at year end and reduce the tax risk that investors face in the future. 

Additional educational resources:  Register before September 30 for Early Bird Offers:

• Especially For Seasoned Tax Accounting and Wealth Advisors:  CE Summit November 1, 2023 – Year End Tax Planning for Investors and Business Owners
• Specialized Credentials for the entrants to the Tax Preparation Industry:  DMA™ Personal Tax Services Specialist Program and the DMA™ Accounting Services Specialist Program
• Specialized Credentials for Tax Accounting Offices:   DMA™ Corporate Tax Services Specialist