Canada 1031 exchange - Eh?

Question

hi - wondering if there is an Equivalent to the 1031 exchange in Canada - or more spec in ONT?

Can i defer my Cap Gains to some other item, purchase or method?  Please say YES!!

Roy N. · Answer

No, there is not a 1031 equivalent in Canadian Tax law.

Tristan - you likely stumbled across Section 44 of the tax code which deals with "replacement properties".   {From the article you linked ... and the code itself}, this only applies when the property:

(i) Has been stolen, destroyed, or expropriated (often referred to as an “involuntary disposition”),or

(ii) Was real estate used by the taxpayer (or a related person) primarily for earning income from a business, but rental property (and any land subjacent to the rental property or land that is contiguous to the rental property that is a driveway, yard, parking area, garden or that is otherwise necessary for the use of the rental property) is specifically excluded. This subset of property is specifically defined as a “former business property” under subsection 248(1) of the Act.

Elise Frappier · Answer

I was looking into it the other day and found this, but you may not quite like my answer. Two parts to it; 1- There is a similar code in Canada, but it CANNOT be used on rental properties. 2- A canadian buying in the US should AVOID using 1031 to avoid paying double in taxes.

http://agtax.ca/cra/canadian-replacement-property-rules

http://moodysgartner.com/can-canadian-taxpayers-defer-a-gain-on-a-disposition-of-property-by-reinvesting-the-sale-proceeds-like-us-taxpayers-can/

The incongruity between IRC § 1031 and the Canadian replacement property rules could lead to devastating tax results on Canada-US cross border transactions. A Canadian individual who owns rental property in the US is entitled to non-recognition treatment under § 1031. However, section 44 and subsection 13(4) of the Act will not apply because the property sold is a rental property. As such, the Canadian individual will recognize any capital gain and depreciation recapture in the year of the sale for Canadian tax purposes.

Normally, the foreign tax credit regime protects Canadian taxpayers against double taxation. In the above example, because of the application of § 1031, no US income tax is payable in the year of sale and consequently, no foreign tax credit will be available under section 126 of the Act. Therefore, the Canadian individual will be subject to the full amount of Canadian tax on the capital gain and depreciation recapture arising on the sale. However, the gain and depreciation recapture is merely deferred for US tax purposes, and these will eventually be realized on a future sale that is not accompanied by a § 1031 Exchange. At that moment, all gains and depreciation recapture will be subject to US taxation and because these were previously subject to Canadian tax, section 126 will not grant a foreign tax credit for the US tax paid, leading to double taxation.

Lyuyuan Zhao · Answer

So after reading all the responses above, is it correct for me to conclude by saying that: There is NOT a Canadian law that is equivalent to the 1031 exchange in the US, and therefore Canadian real estate investor (investing in Canada) do not have the privilege to defer taxes in the way that Americans do?

Roy N. · Answer

@Elise Frappier

The "replacement property" rules in Section 44 of the Canadian Tax Act - which were covered further-up in the thread - serve a very different purpose than §1031 in the U.S.A. income tax act and the two cannot really be compared.

Paul MacInnis · Answer

@Roy N. - interestingly - this section 44 is of utmost interest me as my small multi-family that burned earlier this year (aka - involuntary disposition) will HOPEFULLY shelter me from a somewhat large cap gain this tax year!   I have multiple accountants looking into this for me! :)

Account Closed · Answer

I am just reading about this topic right now here, and seemingly a Yes if certain criteria are met.. Hope this helps

Roy N. · Answer

That about sums it up.  Different country, different rules.

Roy N. · Answer

@Jack Young

How I hold my properties (in a corporation and trust) may not be appropriate for you.  Best to jot down your short, mid, and long-term objectives and then spend a few dollars with your accountant and attorney to build your road-map.

Starting out, it is often beneficial to hold your properties in your own name (depending on your marginal tax rate).  If further down your road you may be rolling your properties into a corporation, you will want to take measures to mitigate any taxation and the time you roll-over (Note:  Depending on your situation, it is possible to roll a property you own alone into a corporation where you are the sole (or primary ... 95%+) owner without incurring a taxable event).

If you will be rolling a property into a company with partners (other shareholders) ... where there will likely be a taxable event ... then you want to plan in advance ... and may or may not want to claim CCA as there will be recovery when the property is deemed to have been sold.

There are several differences between holding property in your name versus in a corporation.  In your name, the revenue from rent is taxed at your marginal tax rate.  In a corporation, rent is considered passive revenue taxed at the highest corporate tax rate ... so unless, your marginal tax rate is in the same ballpark, it might be preferential to hold the properties in your name.

In both instances, expenses can be deducted against revenue.  If your expenses are greater than your rental revenue (say you bought a vacant property and spend more repositioning it than your rentals earned in the year), you can deduct them from other personal income when properties are in your own name.  In the corporation, once you exceed the income of the company, you cannot deduct against your income (as the corporation is a different "person" in the eyes of the CRA).

Jack Young · Answer

@Roy N, can you comment further on how you hold the properties? Does it make a difference if you have formed a company or a corporation? Also I do not use CCA on one of them as I have understood it may not help if you plan on selling in the near future.

Bill Exeter · Answer

Hi @Roy N.,

Yes, I noticed that, but thought I would jump in here because sometimes because of dual citizenship, green card status, cross border businesses, etc., there might be a U.S. income tax consequence, so I thought I would clarify in case any other readers were wondering.

Canada 1031 exchange - Eh?

Most Popular Reply