What are the tax rules for disposition of property related to real estate?
A disposition of property can be categorized as business income or as a capital gain or loss. There are various factors to consider in determining if the disposition is business income or capital for a corporation.
As capital gains are only 50% taxable in Canada, it is generally more favorable for the taxpayer. However, capital losses are only deductible against capital gains. The capital losses can be carried back 3 years and carried forward against future capital gains. Therefore, your tax advantage may vary depending on the situation.
In real estate, the factors to consider for characterization of income vs. capital are:
- Relation of the transaction to the taxpayer’s business
- Number and frequency of the transactions
- Nature of the property and period it is held
- Factors motivating the sale
For example, if a developer claimed a capital gain on disposition of vacant land, it may be challenging to prove that it was an investment as they are in the business of real estate development. On the other hand, an auto-body shop that is incorporated would have an easier time claiming the disposition as a capital gain. If a corporation has a history of buying and selling properties, then the disposition would likely be considered business income and not capital. Factors such as financial difficulties, forced rezoning or unsolicited third party offers may make it easier to claim a capital gain.
Pre-sales are common in real estate where a buyer may enter into a purchase agreement and pay a deposit into trust. However, income is generally only taxed when goods or services are delivered. Therefore, if the expected completion date was not until 2 years, then it should be recorded as unearned revenue. In a purchase agreement for sale of property, the legal title is transferred to the purchaser when the entire purchase has been paid. The disposition is recorded when the purchase takes possession of the property.
If a depreciable property such as a building is disposed, then there may also be recapture of tax or a terminal loss to claim on the tax return (see FAQ #165 for more information).
If you would like more information on dispositions of property related to real estate, please contact us.