Chapter Objectives

1
Chapter Objectives

• Be able to
• Explain the difference between capital income and
  business income.
• Apply the general rules in determining capital
  gains and losses.
• Identify and apply the special rules related to
  capital losses.
• Identify the specific capital properties that
  have special rules and apply them in computing
  capital gains and losses.

2
Capital Property Defined

• In order for a property to be classified as a
  capital property, it must have been acquired and
  used for the purpose of providing the owner with
  a long-term or enduring benefit. The key is
  establishing the intended purpose of the
  acquisition as the definition does not require
  that it be held for the long-term or that it must
  provide a benefit.
• The nature of the asset is not relevant since the
  same property may be capital property to one
  taxpayer and inventory, part of a business
  activity, to another.
• There are four factors which should be taken into
  account together in establishing the taxpayers
  original intention period of ownership, nature
  of the transaction, number and frequency of the
  transactions, and relation of transaction to
  taxpayers business.
• When there is a change in use of the property,
  the CCRA has a policy that the gain can be
  allocated between capital and business income.

3
Categories of Capital Property

• For the purpose of Canadian securities, an
  election can be made to treat all such
  transactions as capital income. However, the
  election is in force indefinitely. One of the
  implications is that losses will be capital
  losses and, thus, only deductible against capital
  gains.
• Personal use property is property that is used
  primarily for the personal use or enjoyment of
  the taxpayer and does not generate any financial
  returns.
• Listed personal property is personal use property
  that has some element of investment value such
  as jewellery, stamps, coins, paintings, and
  sculptures.
• Financial property is property that was acquired
  primarily to generate a financial reward such as
  shares, bonds, land, building, equipment, an
  vehicles.

4
General Rules for Determining Capital Gains
(Losses)

• The capital gain (loss) is calculated by
  deducting the adjusted cost base and expenses of
  disposition from the proceeds of disposition
  (POD). The taxable capital gain (loss) is
  one-half of the capital gain (loss).
• However, if capital losses exceed capital gains,
  the net result must be carried over to other
  periods as a net capital loss which is only
  deductible against capital gains in those other
  periods.
• Normally, a capital property is disposed on when
  sold and the POD is the fair market value of the
  property received in exchange. However, capital
  property may be disposed of under other
  circumstances and there are special rules to deal
  with them.
• The adjusted cost base (ACB) is the original
  purchase price plus related costs such as
  brokerage and installation costs. Expenses of
  disposition would be similar related costs.

5
Deferred Proceeds

• When the vendor of a capital property accepts
  payment over a number of years, the related
  capital gain can also be allocated,within limits,
  over a number of years.
• The deferred recognition of capital gains is
  restricted to a maximum of five years and a
  minimum of 20 of the capital gain must be
  recognized, on a cumulative basis, for each of
  the five years.
• This method for recognizing capital gains is
  optional for each property sold.
• The five-year limit is extended to ten years when
  the sale is to a child and the property sold is
  small business shares or farm property.
• This is a permitted reserve and it is
  discretionary.
• If the buyer assumes a debt as part of the
  purchase, then the amount of equity in the
  property can be substituted for total proceeds in
  the calculation.

6
Unique Aspects of Capital Losses

• Loss on a loan to or shares in a small business
  corporation qualify as an allowable business
  investment loss (ABIL). Although this loss is a
  capital loss, it is treated as a non-capital loss
  and can be deducted against all sources of
  income. However, after the seven-year carry
  forward period, it converts back to a net capital
  loss carry forward.
• When an outstanding debt of a corporation is
  established to be a bad debt, the loan can be
  deemed to be disposed of and, thus, trigger a
  capital loss before the debt is actually disposed
  of.
• There is a similar provision for shares of a
  corporation but the deemed disposition can not be
  triggered until the corporation has become
  legally bankrupt or equivalent.

7
Unique Aspects of Capital Losses (continued)

• It is impossible to have a capital loss on the
  disposal of depreciable property.
• When a capital property is disposed of for a loss
  and then reacquired within 30 days before or
  after the date of disposition, the resulting loss
  is classified as a superficial loss, deemed to be
  nil for tax purposes, and added to the ACB of the
  reacquired asset. The same rule applies when the
  asset is sold to a related corporation or his/her
  RRSP.
• Losses on personal use property (PUP) are deemed
  to be nil and can not be used to offset gains on
  personal use property which is taxable.
• Losses on listed personal property (LPP) are
  recognized but they are only deductible against
  gains on listed personal property.
• Assets of PUP or LPP that cost less than 1,000
  are deemed to have a cost of 1,000 and have POD
  of 1,000.

8
Unique Aspects of Specific Capital Properties

• When identical properties are purchased over
  time, the weighted average should be used in
  computing ACB. An example is shares.
• When securities are converted or exchanged for
  shares of the same corporation, the ACB of the
  old security becomes the ACB for the new
  security.
• If the purchaser of an option exercises it, the
  cost of the option is added to the ACB of the
  property purchased. If the option is allowed to
  expire, the cost is treated as a capital loss in
  the year of expiry.
• When the seller of an option receives payment, it
  is immediately treated as a capital gain. If the
  option is exercised in the future, the option is
  added to the POD and the capital gain is
  determined and the tax return for the prior
  period would be revised to eliminate the capital
  gain.

9
Unique Aspects of Specific Capital Properties
(cont)

• For the purpose of commodities and commodities
  futures, an election can be made to allow
  taxpayers to choose between capital and business
  income. The election must be used consistently in
  future years.
• Gains or losses on the sale of eligible capital
  property, such as goodwill, is treated as
  business income.
• Although principal residences are personal use
  property and their gains are taxable, there is a
  special exemption to eliminate the gain on the
  disposition of a principal residence. If there is
  more than one principal residence, only one may
  be designated for the special exemption in any
  particular year.
• Mutual fund distributions retain the
  characteristics of the original source
  transactions.

10
Real Estate Used to Carry on a Business

• There are special rules regarding the replacement
  of real estate used to carry on a business as
  long as the replacement property is used for a
  purpose similar to the original property.
• If the replacement is voluntary and the real
  estate is replaced by the end of the taxation
  year following the year of disposition, the gain
  will reduce the ACB of the replacement property.
  This exception does not apply to real estate used
  to earn property income from rentals.
• If the replacement is involuntary, such as
  expropriation, and the real estate is replaced by
  the end of the second taxation year following the
  year of disposition, the gain will reduce the ACB
  of the replacement property.
• Neither of the exceptions apply to personal use
  real estate.