Introduction–Involuntary Tax Dispositions
Taxpayers who dispose of a property and receive proceeds that are greater than the total cost to them of the property have realized a capital gain and are required to include half of that amount in their income by the Canadian Income Tax Act. The most common way for a taxpayer to dispose of a property is to voluntarily transfer the property to someone else via a sale or gift. However, voluntary transfers are not the only event which qualifies as a disposition under the Canadian Income Tax Act. A variety of other events such as expropriation are also considered dispositions for Canadian income tax purposes. Since dispositions can lead to large tax liabilities for taxpayers, it is important for taxpayers to be able to identify when a disposition has occurred and in which taxation year the disposition occurred. The basic rule for determining when a disposition took place for tax purposes is when the taxpayer became entitled to receive the proceeds of the disposition. This rule is often straightforward when applied to simple sale transactions, but is not straightforward to apply to some of the other events considered to be dispositions by the Canadian Income Tax Act.
Events Triggering a Tax Disposition
The Canadian Income Tax Act defines a disposition as any transaction or event entitling a taxpayer to proceeds of disposition for a property. When a taxpayer sells a property, the money or other valuable consideration he or she receives from the purchaser is the proceeds of disposition for the property. The taxpayer has disposed of the property as soon as the taxpayer acquires an absolute and unconditional legal right to the proceeds. How this applies to a sale depends on the particulars of the transaction. For example, in the sale of real estate, the seller is required to be able to produce good title to the property at the time of closing. If the seller is unable to do so, the buyer will typically be able to walk away from the deal. This means that in a normal real estate sale the seller will not have an unconditional legal right to the purchase price of the property until the closing of the transaction. When a taxpayer gives away a property, the Canadian Income Tax Act deems the taxpayer to have received proceeds of disposition for the property equal to the fair market value of the property at the time of the gift.
A variety of involuntary events regarding a property can also lead to dispositions under the Canadian Income Tax Act. Canadian tax law considers both compensation for the expropriation of property under statutory authority and compensation for the unlawful taking of property to proceeds of disposition. This means that involuntary transfers of property also result in dispositions and may lead to tax liability if the taxpayer receives sufficient compensation for the lost property. The compensation for the destruction of a property paid under an insurance policy is also treated by the Canadian Income Tax Act as being proceeds of disposition, so the destruction of a property can also be a disposition. The insurance payment for damage to a property is also considered proceeds of disposition except to the extent it is used to repair the property within a reasonable amount of time from when the damage was inflicted.
There are also several circumstances in which Canadian Income Tax Act also deems taxpayers to have disposed of their property by selling it at fair market value and then immediately repurchase it at fair market value despite the absence of any transactions. In particular taxpayers are deemed to have disposed of all of their property in this manner when they die. Taxpayers are also deemed to have disposed of all their property except taxable Canadian Property in this manner when they cease to be a tax resident of Canada, or in other words when they emigrate.
Timing of Involuntary Tax Dispositions
It is important to determine which taxation year a disposition falls into because that determines when the taxpayer will need to include resulting capital gain in their income or be able to access the resulting capital loss and to report it on their tax return. The general principle for determining when a disposition occurred is that the disposition took place at the time that the taxpayer became unconditionally legally entitled to the proceeds of disposition. For the paradigm case of a disposition, the sale of real property, the disposition occurs when the taxpayer becomes legal entitled to receive the proceeds of the sale. As explained above this means the disposition typically occurs when the sale is closed, not when the sale contract is executed.In the case of involuntary dispositions, the Canadian Income Tax Act provides additional rules to clarify when a disposition took place. When a taxpayer is treated as having disposed of a property that was destroyed or taken, lawfully or unlawfully, by someone else then typically the property is treated as being disposed of on the earliest of the following dates:
- The day the taxpayer agrees to an amount as the full compensation for the destroyed or taken property;
- Where the taxpayer has made a claim before a tribunal or court, the day on which the taxpayer’s compensation for the property is finally determined by the tribunal or court; or
- Where no claim has been made before a tribunal or court, the day that is two years following the day of the destruction or taking of the property.
The timing of a deemed disposition is specified by the Canadian Income Tax Act for each particular type of deemed disposition. The deemed disposition that occurs on the death of a taxpayer occurs immediately before the death of a taxpayer while the deemed disposition that occurs when a taxpayer ceases to be a resident of Canada occurs immediately prior to when the taxpayer ceases to be a resident of Canada. If you think you may be subject to a deemed disposition, or are planning to leave the country, or wish to reduce taxes on death through an estate tax plan, please contact one of our top Toronto tax lawyers for help incorporating the disposition into your tax plan.
Tax Tips–Involuntary Dispositions
It is important to know if a disposition has occurred because it can result in tax liabilities that need to be addressed. Since as explained above, not all dispositions occur on the sale of a property, it is important be aware of the involuntary or deemed dispositions that may be relevant for you. If you become aware that a disposition occurred in a previous tax year that you did not report on your tax return, you may be able get penalty and interest relief by reporting the disposition through the voluntary disclosures program. If you think you may be eligible for a voluntary disclosure, please contact one of our expert Toronto tax lawyers.
The deemed dispositions which occur when a taxpayer departs from Canada or dies can lead to the realization of large capital gains. Taxpayers who proactively plan how to deal with these events can sometimes significantly reduce the amount of tax they have to pay when the event occurs. If you are interested in estate planning or departure tax planning, please consider speaking with one of our top Toronto tax lawyers.
If your property has been destroyed or expropriated and you have purchased a new property as a replacement, you may be able to defer part or all of the capital gain realized on the disposition of the original property. The rules surrounding the replacement property rollover are complex, so it is essential to consult a Toronto tax lawyer to assist you in accessing the rollover.
It is also important to know which taxation year a disposition falls into since that will determine when you are required to pay the Canada Revenue Agency or when you have access to the capital losses from the disposition. It is sometimes possible to influence the taxation year that the disposition takes place in. For example, if your property was expropriated and a court or tribunal has reached a decision regarding how much compensation you will receive, you can defer the disposition by appealing to a higher court or tribunal if that is possible. Due to the length of court proceedings, it is possible to realize a significant tax benefit by delaying the income inclusion from a large capital gain through an appeal. If you are considering applying a capital gains deferral strategy, please consider consulting one of our experienced Toronto tax lawyers.