What are the replacement property rules for taxation?
If a replacement property is purchased that costs at least the same amount as proceeds received on the sale of old property, there should be no recapture (see FAQ #165) or capital gains. However, an election is required to be filed with CRA in the corporate tax return when the replacement property is acquired. There are other rules that exist for a voluntary disposition such as: if the former property was being used for earning business income and not rental income, then the replacement property must be acquired within 12 months of end of taxation year of disposition.
An involuntary disposition can occur if a property earning business or property income earning is destroyed (such as in a fire) or expropriated. The replacement property must be acquired within 24 months of the end of the taxation year when property was disposed.
Under subsection 44(2) of the Income Tax Act, the proceeds for involuntary dispositions are deemed to be received when:
a) the day the taxpayer has agreed to an amount for full compensation
b) a legal claim or proceeding in court has determined an amount
c) if there is no claim in court, then 2 years after day of involuntary disposition
The replacement property must be used for the same or similar use as the former property. CRA will apply a reasonable test to ensure that it fits the criteria. Replacement property rules do not apply to rental properties unless rented to a related property for the purposes of earning active income.
If you would like more information on replacement property rules, please contact us.