Replacement property rules can alleviate tax burden

Are you contemplating swapping land with a neighbour? What about relocating your farm entirely? Maybe there is land in your farming company that you want to swap with personal farmland for your estate plan?

You may get heartburn when you think about the tax consequences of selling or transferring land.

However, the replacement property rules can alleviate the tax burden that you incur on the sale of land.

Generally when you sell land, the increase in value would mean a taxable gain on the sale.

For example, if you sold land for $640,000 and your original cost was $140,000, you would have a capital gain of $500,000. For a corporate farm, you are looking at tax of about $125,000 before other tax planning.

The replacement property election allows you to defer the gain when you sell land by purchasing new land to replace it.

The capital gain you have from the initial sale of land may be deferred to the extent the proceeds are reinvested in a replacement property. If you only reinvest a portion of the proceeds to purchase new land, you may only defer a portion of the gain on the sale of land.

The reason we say “tax deferred” is the cost of the replacement property is reduced by the extent of the deferral. Therefore, if the new land is sold in the future, it will have a lower cost and you will pay the additional tax at that time.

There are certain criteria that must be met in order for the replacement property election to be allowed. The criteria includes:

  • The new property you buy must be the same or similar to the old property you replaced and used for the same or similar purpose. For example, you cannot sell farmland and replace it with quota.
  • You have 12 months following the taxation year end in which a property was sold voluntarily to purchase a new real property (i.e. land or buildings).
  • You have 24 months following the taxation year end in which a real property was disposed of involuntarily to purchase a replacement property.

A few tips and tricks in regards to the replacement property election include:

  • If you do not replace the property until the following tax year, the government requires you to pay the tax upfront and then request for it to be refunded when a replacement property is purchased. To avoid having to pay the government upfront, you may want to purchase the replacement property before or in the same tax year as the sale of the old property.
  • You do not need to be concerned of relocating to a different province. For example, you could sell land in Alberta and buy new land in Saskatchewan.
  • Replacement property can also be used on depreciable assets, such as buildings for your farm.
  • Be careful if you are replacing quota or water rights. The replacement property rules can no longer be used on intangible assets such as these on a voluntary disposition.

Taking advantage of the replacement property election can provide current tax savings. Be sure to discuss any plans to sell and purchase property with a tax and business adviser.

Colin Miller would like to thank Riley Honess and Ashton Phillips of KPMG for their assistance with writing this article.

Colin Miller is a chartered accountant and partner with KPMG’s tax practice in Lethbridge. Contact: colinmiller@kpmg.ca

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