Tax Tips

• Tax Tips Archive

Capital Gain Reserves

Subject: Capital Gain Reserves Number: 06-26 Date: 10/13/2006

Capital Gains are taxable over five or ten years depending on the timing of the proceeds and the asset sold

When a capital property is disposed of, a taxpayer can claim a capital gain reserve for the proceeds to the extent that they have not yet been received. The individual is required to calculate as the reserve a “reasonable” portion of the gain.

Generally, the capital gain reserve is calculated as:

• capital gain x balance receivable at the end of the taxation year;
  selling price

This calculation is subject to another limitation. The reserve cannot exceed the lesser of:

1. The amount calculated above; and
2. One-fifth of the total capital gain x 4 minus the number of preceding taxation years
                                                                          ending after the disposition

This means that, in the first year of disposition, not more than four-fifths of the gain can be taken as a reserve. Each year the calculation must be repeated to determine the amount of the reserve. Consequently, the capital gain will be taxed over a maximum of five years.

Where a transfer of a capital asset is made to a child, grandchild, or great-grandchild who is a resident of Canada, and the asset was:

1. Family farm property;
2. A share in the capital stock of a family farm corporation;
3. An interest in a family farm partnership; or
4. A share in the capital stock of a small business corporation,

the maximum capital gain reserve is calculated using a ten-year timeframe instead of five years. Consequently, in the first year a reserve of 90% could be claimed. The taxpayer has ten years to include the entire capital gain in income.

A taxpayer does not have to claim the maximum available reserve. He or she cannot claim a reserve in a subsequent year greater than the reserve claimed in the prior year. Therefore, if an individual claims a reserve of $5,000 in one year, the reserve in subsequent years can never be greater than that. A reserve cannot be claimed if the acquirer was a corporation, which, immediately after the acquisition of the capital property, was controlled directly or indirectly by the transferor of the property. The reserve is also disallowed for individuals who become non-residents during the year. If a reserve were claimed in the prior year, and the individual leaves Canada, a reserve cannot be taken for the year of departure. The prior year’s reserve will come into income in the year of departure with no reserve for the year of departure.

TAX TIP OF THE WEEK is provided as a free service to clients and friends of the Tax Specialist Group member firms. The Tax Specialist Group is a national affiliation of firms who specialize in providing tax consulting services to other professionals, businesses and high net worth individuals on Canadian and international tax matters and tax disputes.

The material provided in Tax Tip of the Week is believed to be accurate and reliable as of the date it is written. Tax laws are complex and are subject to frequent change. Professional advice should always be sought before implementing any tax planning arrangements. Neither the Tax Specialist Group nor any member firm can accept any liability for the tax consequences that may result from acting based on the contents hereof.