On June 1, 2013, Mario entered into a contract to sell real estate for $1 millio
ID: 2559705 • Letter: O
Question
On June 1, 2013, Mario entered into a contract to sell real estate for $1 million (adjusted basis $200,000). The sale was conditioned on a rezoning of the property for commercial use. A $50,000 deposit placed in escrow by the purchaser was refundable in the event the rezoning was not accomplished.
After considerable controversy, the application was approved on November 10, and two days later, the sum of $950,000 was paid to Mario’s estate in full satisfaction of the purchase price. Mario had died unexpectedly on November 1. Discuss the estate and income tax consequences of this set of facts if it is assumed that the sale of the real estate occurred:
a. After Mario’s death.
b. Before Mario’s death.
When do you think the sale occurred? Why?
I KNOW IF THE CONTRACT IS EXECUTED BEFORE MARIOS DEATH THEN HE WILL BE BINDING ON THE SALE AND TAX IMPLICATIONS ARISE BUT I NEED TO DISCUSS THE TAX IMPLICATIONS PLEASE HELP
Explanation / Answer
Sale will occur only after approval from Zoning board and where consideration has been received and seller is ready to give possession and ownership
Tax implication
Land which becomes significantly more valuable if proposed zoning changes are adopted could be subject to a tax on the gain in value from rezoning, if the land is sold within 10 years of purchase and does not fall within some narrow exceptions.
A significant theme of the Unitary Plan is the rezoning of existing strategic urban areas to accommodate intensification and development. The potential for the proposals to significantly increase the value of land that has been zoned for intensification has since been the subject of much media comment – but the possibility of some property owners materially benefiting from zoning changes also throws a spotlight on the potential for such gains to be taxed.
A summary of the key recommendations on the Unitary Plan can be found here.
When are rezoned land sales subject to tax?
The “land provisions” in the Income Tax Act subject certain land sales to income tax.
These provisions apply (subject to certain exclusions) in various well known circumstances, including where the land that is sold was acquired with the purpose or intention of resale, was acquired for the purposes of a business relating to land, or is disposed of within two years of acquisition.
The land provisions also include a lesser-known rule taxing gains made from the disposal of “land affected by change”. This rule provides that a gain on the sale of land is taxable where:
In short, the rule could apply where a person sells land within 10 years of acquiring it and 20 per cent or more of the gain they realise is attributable to a change in zoning set out in the Unitary Plan.
Exclusions to the rule
This rule is subject to exclusions for sales of residential land and farm land. In the case of residential land, the rule does not apply where the person selling the land acquired and used it (or at least intended to use it) for “residential purposes”, and sold the land to another person who has also acquired the land for residential purposes. The term “residential purposes” means the use of the land mainly as a residence for the person acquiring the land and members of their family.
The sale of a home by a person to a land developer would not fall within this exclusion. The exclusion would also not apply to investment properties.
Some relief – a deemed deduction
Where the rule applies, the person has a deemed deduction equal to 10 per cent of their gain for each year they held the land. For example, if a $100,000 gain was made on the sale of land held for four years and that gain was taxable under this rule, then a $40,000 deemed deduction would be available so that tax was payable on only $60,000.
Potential for broad application of this provision in respect of land rezoned under the Unitary Plan
We do not believe this rule has been heavily relied upon by the Inland Revenue Department since the introduction of its predecessor provision in 1975. It has only been the subject of a relatively small number of cases since then.
The introduction of the Unitary Plan could allow for an unprecedented level of urban intensification, which may result in a significant increase in the number of taxpayers potentially subject to this rule.
It is unlikely that an event like the release of the Unitary Plan would have been contemplated when the rule was introduced, the legislature possibly having in mind windfall gains made by land owners on the urban/rural boundary that derive from zoning changes. Given the potential consequences of this rule, there is a strong case for a review of its scope to ensure it operates appropriately having regard to current tax policy settings.
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