Canadian Replacement Property Rules
Many Canadian often confuse the Canadian replacement property rules under Section 44 to be similar to that of the U.S. Internal Revenue Code (IRC) Section 1031 Like-kind Exchange; often when it is regarding their property situated in the U.S. However it is important for Canadian taxpayers thinking of taking advantage of the replacement property rules to understand that the rule varies. And in order to provide some guidance to our taxpayers, the cross-border tax analysts at AG Tax have prepared a brief overview of the Canadian replacement rules. Nonetheless, it is best to consult a tax professional before executing such tax measures.
Section 44 of the Canadian Income Tax Act
As per the ITA §44 or §44.1, a taxpayer may defer gain on a sale by rolling into a replacement property, provided the existing property was stolen, expropriated by government, or destroyed, and/or used by the taxpayer to generate income (excluding rental income) from a business.
The seller should acquire another property in place of the disposed property within a certain time period. This should be similar to the disposed property, or used for the same purpose in order to qualify for the tax deferral of the gain (by reducing the tax cost of the replacement property) realized on the former property.
While §44.1 applies to certain Canadian private corporation shares where all or a significant amount of assets are used actively in the business, and the total carrying value of the assets is less than $50,000,000.
How is it Different from U.S. IRC §1031: Like-Kind Exchange
Under U.S. IRC §1031, a taxpayer will not recognize any gain or loss on the exchange of one property for another like-kind property, assuming that when the taxpayer exchanges a property for like-kind property, he/she is simply holding on to the original investment rather than disposing off one property for another, provided the property(ies) fulfill certain conditions, such as:
- It is an exchange of property;
- The exchanged properties are used for trade/business or for investment; and
- The exchange should take place within 45 days, and the ownership should be transferred within 6 months.
However, the ruling does not apply to the exchange of certain properties, such as: inventory, stock, bonds, or notes; interests in a partnership; trust certificates of trust or beneficial interests; etc.
Properties Located Outside Canada
It is quite clear that the U.S. ITA §1031, Like-Kind Exchange rule is much broader than the Canadian ITA §44 or 44.1 extending to include rental properties too, making it more complicated for Canadians owning properties in the U.S. and trying to benefit tax-wise by replacing the property.
Canadian owners of U.S. rental property should be informed that under U.S. IRC §1031 if the exchanged property is purchased within 6 months from the sale of the actual property, and all the required conditions (mentioned above) are fulfilled, they can benefit on the U.S. tax side by applying the §1031: Like-Kind Exchange rules but unfortunately on the Canadian tax front they cannot benefit from the Canadian ITA §44: Replacement Property rules since the sold property is a rental property; and any gain and/or depreciation recapture will be realized in the same year.
Foreign tax credit (FTC) may be available to avoid double taxation, but in case the U.S. rental property is held by a Canadian corporation, FTC may not be available to avoid double taxation.
Given the complications involved during the sale of foreign properties, such as: U.S. property; it is best to consult a tax professional not only during the sale but also while creating the ownership for such rental property.
AG TAX LLP Can Help
Tax situations can be complicated, especially when it involves the tax rulings of two or more countries, and complying with the tax regulations may be further stressful if there are possibilities of penalties for non-compliance.
If you have any tax-related queries or need assistance with tax planning or filing please contact AG Tax. Our tax professionals are highly-experienced with U.S. and Canadian tax laws and can provide you the right guidance to handle your tax situation.
Aylett Grant Tax LLP is a full service accounting firm with a dedicated team of experts, who are highly-qualified and experienced in handling situations related to U.S., Canada and other international tax laws.
We can assist with:
- Canadian Personal and corporate tax returns
- Cross Border Taxation and Business Planning
- U.S. Personal and Corporate Taxation
- Disclosure of Foreign Assets and other information filings
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Disclaimer: The information in this publication is accurate as of the time of its publication. AG Tax assumes no responsibility for changes to tax legislation subsequent to the publication of this document. The information provided is for general information purposes only and should not be acted upon without seeking professional advice. If you would like to engage our services, please contact our staff and obtain authorization to send our firm confidential information. A client relationship is not created by the transmission of information. A client relationship is only formed with our firm when a scope and engagement letter signed by the firm and the potential client detailing the terms of engagement is present.
