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Did you know that the destruction of a building, as was the case for many properties in downtown Lac-Mégantic, is an actual disposition for tax purposes and can represent a heavy tax burden for the owner?
The destruction of a building represents an involuntary disposition for the purposes of the Income Tax Act. Very often, the proceeds of disposition come from the amount of insurance received as compensation. A capital gain or recaptured depreciation then could be realized and trigger a tax expense.
Fortunately, a tax election exists, commonly known as “replacement property election”, that allows a taxpayer to defer recognition of income or a capital gain when there has been an involuntary disposition of “former property” (destruction, expropriation or theft).
The main conditions required to exercise such a tax election are as follows:
- It is reasonable to conclude that the property was acquired by the taxpayer to replace the former property;
- The property was acquired by the taxpayer and is used by the taxpayer or a related person for a use that is the same or similar to the use to which the taxpayer or the related person put the former property.
- If the taxpayer or a related person used the former property to earn income from a business, the property must have been acquired for the purpose of earning income from the same or a similar business or for a person related to the taxpayer who uses it for this purpose.
A certain correlation or cause-and-effect relationship must exist between the involuntary disposition of the building and the acquisition of the new building. In particular, they must have the same physical features.
The tax authorities consider that the geographical location of the replacement property is not a determining factor. The replacement property thus could be constructed elsewhere than at the initial location of the subject property.
Finally, to be valid, such tax election must be made within 24 months of the end of the taxation year of the deemed disposition or destruction of the property.
Please do not hesitate to consult us if you have any questions about replacement property election or any other tax question.