Change in use of property from capital to inventory or vice versa.

There are no immediate repercussions for the change in business use of property from capital to inventory. The differences arise upon sale of the real estate.

There is no provision in the Income Tax Act which describes the circumstances in which gains from the sale of real estate are to be determined as being either income or capital.

However, in making such determinations, the courts have considered:

(a) the taxpayer’s intention with respect to the real estate at the time of its purchase;

(b) feasibility of the taxpayer’s intention;

(c) geographical location and zoned use of the real estate acquired;

(d) extent to which intention is carried out by the taxpayer;

(e) evidence that the taxpayer’s intention changed after purchase of the real estate;

(f) the nature of the business, profession, calling or trade of the taxpayer and associates;

(g) the extent to which borrowed money was used to finance the real estate acquisition and the terms of the financing, if any.

(h) the length of time throughout which the real estate was held by the taxpayer;

(i) the existence of persons other than the taxpayer who share interests in the real estate;

(j) the nature of the occupation of the other persons referred to in (i) above as well as their stated intentions and courses of conduct;

(k) factors which motivated the sale of the real estate;

(l) evidence that the taxpayer and/or associates had dealt extensively in real estate.

 

Where real estate that is used for the purpose of producing income is converted from capital property to inventory, conversion itself does not create a disposition. However, at the time of sale there will be a gain or loss that will be treated as capital, income or a combination of the two.

Accordingly, where the real estate has been converted to inventory, capital gains or losses, if any, will be calculated on the basis that a notional sale occurred on the date of conversion. The notional capital gain or loss on the real estate will be the difference between its adjusted cost base and its fair market value on the date of conversion. These notional capital gains or losses will give rise to taxable capital gains or allowable capital losses in the taxation year during which the actual sale of the real estate occurs.

The amount of any income gain or loss arising on sale of the converted real estate will be determined on the basis that its initial inventory value is its fair market value on the date of conversion.

The following examples illustrate the use of the above for non-depreciable capital property.

A B C
Assumptions:
Cost of property when acquired (1) $ 10,000 $ 10,000 $ 10,000
Fair market value at date of conversion (2) $ 15,000 $ 8,000 $ 7,500
Cost of additions made after conversion (3) $ 4,000 $ 4,000 $ 4,000
Proceeds of sale (4) $ 16,000 $ 6,000 $ 20,000
Notional capital gain or (loss) (5) $ 5,000 $ (2,000) $ (2,500)
Income gain or (loss) (6) $ (3,000) $ (6,000) $ 8,500
Effect for tax purposes in year of actual   sale of property:
Taxable capital gain or (allowable capital   loss)-half of (5) $ 2,500 $ (1,000) $ (1,250)
Income gain or (loss) (6) $ (3,000) $ (6,000) $ 8,500
 Total gain or (loss) $ (500) $ (7,000) $ 7,250

Much of this information was taken from IT218R.

If you would like more information or have any questions, feel free to contact us at 780.466.6204, or click here to send us an email.

Thanks to Richard Ouellette of KWB Chartered Accountants for providing this content.

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