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Capital Gain Reserve for Most Property

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Filing Your Return -> 
Stocks, Bonds etc. -> Capital Gains and Losses -> Capital Gain Reserve -> All other property

Capital Gain Reserve - All Other Properties Except Donated Non-Qualifying Securities

Income Tax Act s. 40(1)(a)(iii)

This reserve is available for the deferral of capital gain on disposals of property when the proceeds are received over a number of years.  This article deals with the reserve that is available for most capital property, except for dispositions which are:

bulletDispositions to your child of family farm property, family fishing property after May 1, 2006, and small business corporation shares, and
bulletGifts of non-qualifying securities (other than an excepted gift) to a qualified donee

The reserve is calculated using the following formula:

capital gain x amount payable after the end of the year
total proceeds of disposition

The reserve can be claimed up to a maximum of four years, which spreads out the capital gain over 5 years.  There is a maximum reserve that can be claimed in each year.  The maximum is calculated as a percentage of the capital gain.  The maximum percentage is:

Year of sale

80%
Years after the sale:
1st year 60%
2nd year 40%
3rd year 20%
4th year 0%

Therefore, to spread out the gain over the maximum 5 years, you would have to receive your proceeds of disposition over at least 5 years.

It is not necessary to claim the maximum allowed reserve in any year.  However, if a reduced reserve is claimed in a year, the reserve claimed in the following year cannot exceed that amount.  For instance, if in the year of sale 45% of the capital gain was claimed as a reserve, then the maximum reserve that could be claimed in the next year would also be 45%.  If the 45% maximum was claimed in the next year, the capital gain would be zero, because amount of capital gain in each year is equal to the reduction in the amount of the reserve from the previous year.  If a higher reserve could be claimed in a subsequent year, the result would be the creation of a loss.  This is not allowed.

A person may not have to claim the maximum reserve in a particular year if they have capital losses to offset the capital gain, or if they have business losses to reduce taxable income.  They might also want to shift income to the current year from the coming year, if they know that they will have higher income in the coming year.

Example - sale of real estate which has been used as a rental property:

Proceeds of disposition $800,000
Less cost 500,000
Capital gain  300,000

The proceeds are being received over a period of 5 years.  A $160,000 down payment is made, with annual payments of $160,000 for the next 4 years.  The reserve is calculated as follows, with the original capital gain amount of $300,000 referred to as G (gain) in the formulas shown:

  Capital
Gain Before
Reserve
A
Amount
Payable
After
Yearend
B
Reserve
C = 
G x B

proceeds
Maximum
Reserve
%
D
Maximum
Allowed
Reserve
E = A x D
Capital
Gain After
Reserve
H = A - E
Taxable
Capital
Gain
50% x H
Year of sale $300,000 800,000 - 160,000
= 640,000
300,000 x 640,000
800,000
= $240,000
80% $240,000 $60,000 $30,000
Years after sale:
1st year 240,000 640,000 - 160,000
= 480,000
300,000 x 480,000
800,000
= 180,000
60% 180,000 60,000 30,000
2nd year 180,000 480,000 - 160,000
= 320,000
300,000 x 320,000
800,000
= 120,000
40% 120,000 60,000 30,000
3rd year 120,000 320,000 - 160,000
= 160,000
300,000 x 160,000
800,000
= 60,000
20% 60,000 60,000 30,000
4th year 60,000 160,000 - 160,000
= 0
300,000 x 0
800,000
= 0
0% 0 60,000 30,000

In the above example, the proceeds are received evenly over the 5 years, so the initial reserve calculation equals the maximum allowable reserve.  Note that the capital gain before reserve in the years after the sale is always the amount of the reserve claimed in the previous year.  If no reserve was claimed in any year, then the reserve amount from the previous year would be brought into income as a capital gain.  The amount of capital gain in each year after the year of sale is equal to the reduction in the amount of the reserve from the previous year.

Claiming Less Than Maximum Capital Gain Reserve

In the above example, if the taxpayer decided in the year of sale to claim a reserve of only $170,000, then the capital gain after the reserve would be $130,000 ($300,000 - $170,000).  They might decide to do this if they had capital losses to offset the capital gain, or if they had business losses that would reduce their taxable income.  The maximum allowable reserve in the 1st year after sale would then be $170,000, the same as the year of sale.  If this amount is used it would result in a zero capital gain for the year, because there is no reduction in the reserve amount from the prior year.  See the following for an example, with the capital gain of $300,000 again referred to as G in the formulas shown.

  Capital
Gain Before
Reserve
A
Amount
Payable
After
Yearend
B
Reserve
C = 
G x B

proceeds
Maximum
Reserve
%
D
Maximum
Allowed
Reserve
*
Reserve
Claimed
F
Capital
Gain After
Reserve
H = A - F
Taxable
Capital
Gain
50% x H
Year of sale $300,000 800,000 - 160,000
= 640,000
300,000 x 640,000
800,000
= $240,000
80% $240,000 $170,000 $130,000 $65,000
Years after sale:
1st year 170,000 640,000 - 160,000
= 480,000
300,000 x 480,000
800,000
= 180,000
60% 170,000 170,000 nil nil
2nd year 170,000 480,000 - 160,000
= 320,000
300,000 x 320,000
800,000
= 120,000
40% 120,000 120,000 50,000 25,000
3rd year 120,000 320,000 - 160,000
= 160,000
300,000 x 160,000
800,000
= 60,000
20% 60,000 60,000 60,000 30,000
4th year 60,000 160,000 - 160,000
= 0
300,000 x 0
800,000
= 0
0% 0 0 60,000 30,000

* The maximum allowable reserve is the lesser of G x D, or the reserve from the previous year.

Larger Down Payment Received Changes Capital Gain Reserve

The next example shows what happens with the reserve when a larger down payment is received.  The proceeds and cost are the same as the above example, with a capital gain of $300,000 (again referred to as G in the formulas shown).  However, $300,000 is received in the first year, with annual payments of $125,000 for the next 4 years.  The reserve is calculated as follows:

  Capital
Gain Before
Reserve
A
Amount
Payable
After
Yearend
B
Reserve
C =
G x B
proceeds
Maximum
Reserve
%
D
Maximum
Allowed
Reserve
E = G x D
Actual
Reserve
F = Lesser of
C and E
Capital
Gain After
Reserve
H = A - F
Taxable
Capital
Gain
50% x H
Year of sale $300,000 800,000 - 300,000
= 500,000
300,000 x 500,000
800,000
= 187,500
80% $240,000 $187,500 $112,500 $56,250
Years after sale:
1st year 187,500 500,000 - 125,000
= 375,000
300,000 x 375,000
800,000
= 140,625
60% 180,000 140,625 46,875 23,438
2nd year 180,000 375,000 - 125,000
= 250,000
300,000 x 250,000
800,000
= 93,750
40% 120,000 93,750 46,875 23,438
3rd year 120,000 250,000 - 125,000
= 125,000
300,000 x 125,000
800,000
= 46,875
20% 60,000 46,875 46,875 23,438
4th year 60,000 125,000 - 125,000
= 0
300,000 x 0
800,000
= 0
0% 0 0 46,875 23,438

Tax Tip:  If you are selling capital property, it may be advantageous to carry the mortgage, and spread your gains over 5 years.  Get professional advice on this.

 

Revised: March 02, 2016

 

 

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