Understand deemed disposition and how do reserves work

In Canada, you might have to report a capital gain even if you did not sell anything. This happens when the CRA treats you as having sold property under what is called a deemed disposition. These are automatic events where you are considered to have disposed of an asset, which can trigger a capital gain.

When that gain is large, tax law allows some flexibility through the use of a reserve. A reserve lets you delay paying tax on a portion of that gain if the proceeds are received over time.

This matters when transferring assets to family, leaving the country, or receiving payment in installments. Knowing when deemed dispositions occur and how reserves work can help you plan better and reduce a tax hit.

What Is a Deemed Disposition?

A deemed disposition occurs when the CRA considers that you have disposed of a capital property, even though you did not actually sell it. These events are treated as if a sale occurred at fair market value.

Common situations where deemed dispositions apply:

• Departure from Canada (emigration)
  When you become a non-resident, the CRA assumes you disposed of most capital property at fair market value. This is known as the departure tax.

• Death of a taxpayer
  When someone dies, they are deemed to have sold all capital property right before death unless it transfers to a spouse or spousal trust.

• Gifting property
  If you give capital property to a family member or another person, CRA considers it disposed at its fair market value, even if no money is exchanged.

• Change in use of property
  For example, converting a principal residence into a rental property or vice versa triggers a deemed disposition.

• Transferring property into a trust or corporation
  Unless rollover provisions apply, this may also count as a deemed sale.

• Ceasing to carry on a business
  Some business assets may be deemed disposed when business operations end.

In each of these cases, you may be required to calculate a capital gain and include it on your return, even if no cash was received.

What Are Reserves for Capital Gains?

If you sell a property and receive the payment over several years, the CRA allows you to claim a reserve. This means you only pay tax on the portion of the gain that relates to the amount you actually received in the year.

This applies when:

• You sell a capital property, such as real estate or a business,

• You are paid in installments over more than one year,

• You want to defer some of the taxable capital gain to future years.

How the Capital Gains Reserve Works

The reserve is available for up to five years, starting with the year of the sale. Each year, a portion of the deferred gain is brought into income. By the fifth year, the full gain must be reported, even if not all proceeds have been received.

To calculate the reserve:

1. Determine the total capital gain from the sale.

2. Calculate the portion of the proceeds not yet received at year-end.

3. Multiply that portion by the total gain.

4. Claim that amount as a reserve to reduce the taxable capital gain.

Each year, the reserve is reduced and more of the gain becomes taxable.

Selling a Property with Deferred Payments

You sell land for $300,000 with a capital gain of $120,000. The buyer agrees to pay over three years: $100,000 per year.

• In Year 1, you receive one-third of the proceeds.

  • You report two-thirds of the gain as a reserve and only one-third as taxable.

• In Year 2, you receive another third.

  • You reverse part of the reserve and report a larger taxable amount.

• In Year 3, the remaining amount is received.

  • You report the final portion of the gain and claim no reserve.

Key Differences Between Deemed Dispositions and Reserves