What Is Deemed Disposition?
Subsection 248(1) of the Income Tax Act defines "disposition" as "any transaction or event entitling a taxpayer to proceeds of disposition of a property." For tax purposes, a gain or loss is not recognized until it has been realized by the disposition of the property. However, under certain circumstances, the Canadian Revenue Agency ("CRA") may consider a transfer of property has occurred even if there is no purchase or sale, which is known as the Deemed Disposition. The deemed proceeds of the property disposition are subsequently determined by the CRA at the Fair Market Value ("FMV") of the property.
A Deemed Disposition gives rise to a capital gain or loss although the property is not actually being disposed of. A taxpayer will be liable for paying taxes on the deemed proceeds of disposition if the deemed disposition gives rise to a capital gain and failure to pay taxes on time can trigger penalties and interests.
The most common circumstances are deemed disposition on death of an individual, change in tax residence, gifts, trusts and change of use in property.
Fair Market Value
The Canadian Income Tax Act provides no definition for the term Fair Market Value, which needs to be determined on relevant facts. A common definition that has been accepted by the tax courts came from Henderson v MNR  CTC 636, DTC 5471: "(Fair Market Value is) the highest price an asset might reasonably be expected to bring if sold by the owner in the normal method applicable to the asset in question in the ordinary course of business in a market not exposed to any undue stresses and composed of willing buyers and sellers dealing at arm's length and under no compulsion to buy or sell." The Canadian Revenue Agency ("CRA") adopts a similar definition that Fair Market Value is "normally the highest price, expressed in dollars, that property would bring in an open and unstrict market, between a willing buyer and a willing seller who are both knowledgeable, informed, and prudent, and who are acting independently of each other." In other words, the Fair Market Value ("FMV") is the best price the seller can obtain in an open and competitive market if the buyer and the seller are not affiliated to each other.
In practice, there is no set formula or precise standard to determine the Fair Market Value of a property. Instead, the valuation is based on specific facts and requires professional appraisals. The CRA has the discretion to accept or to adjust the appraisals.
Emigration And Immigration
When a Canadian tax resident leaves Canada and becomes a non-resident in Canada, the CRA deems that the individual has disposed of certain kinds of property at Fair Market Value and immediately reacquired them at the same price. Deemed Disposition at emigration may result in a taxable capital gain that is subject to departure tax. If the total value of all properties the taxpayer owned exceed $25,000 at the time of departure, the taxpayer will be required to file Form T1161 to report certain types of properties, excluding cash, pension/annuities/registered retirement plans, any item of personal-use property that has a Fair Market Value of less than $10,000, and property owned when the taxpayer last became a resident of Canada (if the taxpayer had been a Canadian tax resident for 60 months or less during the past 10 years). The T1161 is an information return that must be submitted whether or not a taxpayer has to file a return. Failure to file the T1161 form by the applicable due date gives rise to a penalty of $25 for each day the form is late, with the maximum penalty capped at $2,500.
Deemed Dispositions also apply in the year that a newcomer has just become a Canadian tax resident. Certain types of foreign properties owed by the individual prior to becoming a Canadian tax resident will be deemed to have been disposed of and required immediately at a cost equal to their Fair Market Value. If the individual incurs a loss from the Deemed Disposition, he or she can only use these losses to deduct gains from selling the same type of property. It is worth mentioning that an individual's tax residence is not directly related to an individual's immigration status.
For more information on individual tax residence, please check out our article on Tax Residence in Canada. If you would like legal advice on your tax residence or legal assistance on residential determination, please contact our experienced Canadian tax lawyers.
Although there is no inheritance or estate tax in Canada, the CRA considers that the deceased person has disposed of all capital property before death, triggering taxation of capital gains if any. If an individual inherits a property from a deceased person, subject to certain exceptions, the property value determines the deemed proceeds of disposition for the deceased, which is equal to the fair market value at the time of death. The exceptions include property inherited from an individual's spouse or common law partner and farm property or a woodlot transferred on death to a child, which may result in different tax treatment of the transferred property. For example, a taxpayer who receives property from his or her spouse because of the spouse's death can elect for a spousal rollover at cost to avoid realizing any gains or losses with respect to that property.
Capital property is subject to Deemed Disposition at the date of an individual's death. Capital property is any property which would result in a capital gain or loss if sold, excluding the trading assets of a business (inventory). Some common types of capital property include stocks, lands, houses, and bonds and potentially Cryptocurrency, depending on trading history and other factors. CRA has set out different rules for depreciable property and farm/fishing property transferred to a child in terms of Deemed Disposition. There are also special rules for property a deceased person owned before 1972 due to the previously applicable inheritance tax.
Our article on Deemed Disposition Upon Death and Double Taxation can provide you with more information on how you can conduct tax and estate planning via Deemed Disposition.
When an individual receives property as a gift, he or she is considered to have acquired the property at its Fair Market Value on the date of receipt. Canada does not have a "gift tax", but a gift may trigger tax on deemed proceeds of disposition if the Fair Market Value of the property exceeds its adjusted cost base thereby resulting in a capital gain. However, in certain situations, regardless of the property value, the Deemed Disposition rule will not be applicable. Similar to the special rules set out for Deemed Disposition on the Death, a spouse or common-law partner who is receiving gift from his or her spouse will be deemed to have acquired the property at the original cost of the property. Other common exceptions include when the gifts were made to a registered charity or when a section 85 election is filed with regards to the transfer of property between corporations.
In Canada, trusts are commonly subject to the "21-year rule", which triggers Deemed Disposition and immediate reacquisition of the property owned by the trust every 21 years. Trusts must file Form T1055, Summary of Deemed Disposition for capital property (other than exempt property), land inventory, and Canadian and foreign resource properties prior to the day when the Deemed Disposition occurs. The day of Deemed Disposition is determined based on the type of trust although it is generally 21 years after the day the trust was created or the day when the beneficiary passes away.
There may be tax planning options available to defer the triggered tax on capital gains. For example, capital distribution of property to beneficiaries rolls the capital property to the beneficiaries without triggering tax while the beneficiaries can continue to hold the property until the sale of the property or their death. The trustees, based on the trust settlement documents, will determine if they are granted the authority to distribute capital assets prior to the day of Deemed Disposition for tax deferral purposes.
Change of Use In Property
A property can be used for income-producing purposes and/or personal use. Deemed Disposition occurs when all or part of the property use changes, which may result in a capital gain proportional to the changes and taxable capital gains. For example, if you choose to convert a rental property to a principal residence, you're deemed to have disposed of the property at the Fair Market Value and you will need to pay tax on the deemed proceeds of disposition.
Under certain circumstances, a section 45(2) election can be filed to defer any taxable capital gain on the Deemed Disposition that will be included in the taxpayer's income for the year. The election must be filed with your income tax return for the year in which the change of use occurs. For more information on filing a section 45(2) election, please contact our experienced Canadian tax lawyers.
Pro Tax Tips - Understand Fair Market Value upon Deemed Disposition
The Fair Market Value of a property is not a set number. Instead, the CRA, taking professional appraisals and opinion into consideration, determines what the highest price that can be obtained in a normal and open business transaction. The CRA may refer to different factors in determining the property value and the Fair Market Value is to be determined on the date of disposition. The timing of the Deemed Disposition may be different, but normally it is either the day a person has become or ceased to become a Canadian tax resident, the day the gift or transfer is completed, the 21st anniversary of the trust or the day when change of use in property occurs.
For more advice on tax planning to minimize your tax obligations on Deemed Dispositions, contact our expert Canadian tax lawyers in Toronto.
Will I Be Taxed Due To Deemed Dispositions of My Property?
Yes, your deemed proceeds of disposition may be taxable under the Income Tax Act. However, under certain circumstances, you may be able to defer paying part or all of the amount owing from the Deemed Disposition of capital property. Whether you qualify for the exceptions depends on the factual scenario of your case and we recommend that you should contact a knowledgeable Canadian tax lawyer for more information.
Is There A Way For Me To Find Out What The Fair Market Value Of My Property Is?
Unfortunately, there is no set price list or reference for assessing the Fair Market Value ("FMV") of a property. A professional appraisal is also not determinative, but it would normally be accepted. The ultimate determination is made by the Canadian Revenue Agency ("CRA"), which assesses the property value at the highest price that can be obtained in a normal and open business transaction. The CRA determination can be challenged in the Tax Court of Canada.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.