Selling a Property and the Year of the Tax Bill

A building sells. The lawyer's trust cheque clears, and the account holds more money than it has ever held. For about six weeks the portfolio feels solvent in a way it has never felt, and every decision made in those six weeks is made while feeling wealthy. Nothing about the balance says which part of it belongs to somebody else.

That is the problem. The money is not all yours, the part that is not yours has a due date, and the date is far enough away to be forgotten. This page is about separating the deposit before it gets spent. Twenty minutes on the day of the deposit decides how the following spring goes.

What does the sale actually trigger?

Two amounts, and the second one surprises people. One of them is expected and one of them is not.

The capital gain is computed under section 40(1) as the proceeds of disposition, less the adjusted cost base and the outlays and expenses of making the sale. A portion of that gain is included in income in the year of the disposition. Most owners expect this and have some sense of its size. Owners generally know roughly what a gain looks like. Selling costs reduce the gain and they are easy to leave out of a quick calculation.

The recapture is the second amount. Where capital cost allowance was claimed against rental income over the years of ownership, section 13(1) brings back into income the amount by which the proceeds exceed the undepreciated capital cost, up to the original cost. That amount is included in income in full and not in part, which makes it heavier per dollar than the gain. Full inclusion is what makes recapture the heavier of the two per dollar. Depreciation claimed in comfortable years is recovered in one uncomfortable one.

The two together are what the return will show. A property that produced comfortable cash flow for fifteen years because depreciation sheltered the income produces a larger bill on sale for precisely that reason. The benefit was taken earlier and the balance arrives now, which is the trade capital cost allowance has always been. The benefit was taken in instalments and the balance arrives in one.

When is the money actually owed?

In the taxation year the disposition falls in, with the balance due on the filing deadline for that year. The closing date fixes the year, and nothing later moves it.

The closing date decides the year. A sale that closes in December lands in that year's return and the balance is due the following spring. A sale that closes in January gives you fourteen months before the balance is payable, which sounds generous and is the version that goes wrong most often, because fourteen months is long enough to forget. A long gap feels like relief and behaves like a hazard. December and January are two very different months to close in.

Two things can accelerate the obligation. A large gain can create or change an instalment obligation for the following year under section 156, so an owner who has never made instalments starts receiving requests. And provincial rules and personal circumstances can shift the arithmetic in ways only your own return shows. Instalment requests arriving for the first time are usually a surprise and not an error. Provincial rules add their own layer to the same calculation.

The instruction is short and it is the whole of the practical advice. Ask your accountant for the estimated number in the month of the sale, and not in the spring. They can produce it from the closing statement and the depreciation schedule in an hour, and knowing it early is what makes everything that follows possible. An hour of an accountant's time in the month of the sale is the cheapest hour in this section. Estimates move as the schedule is confirmed, so ask for a range rather than a single figure.

How is the deposit separated?

Into three parts, on the day it arrives, before anything else happens. Three transfers, made once, and the rest of the year takes care of itself.

The tax portion, at the number your accountant produced, plus a margin because the estimate is an estimate. It goes into an account or a short term deposit that matures before the due date, at an institution separate from your operating bank, and it is not touched. The margin matters because an estimate made before the schedule is final will move. An estimate plus a margin is a reserve; an estimate alone is a hope.

The committed portion, which is any deposit already promised on a purchase under negotiation. It needs to be reachable the same week, so it stays liquid and it also stays separate, because a deposit that sits in the operating account becomes part of the operating account. Committed money and operating money look identical once they share an account. Deposits committed to a purchase are not spare money for anything else.

The uncommitted portion, which is whatever is left after the first two. Only this portion has no date on it, and only this portion is a candidate for a decision with a long horizon. Only this portion should ever be part of a conversation about a long horizon.

Three transfers, on the day of the deposit, taking about twenty minutes. Owners who do this describe the following spring as uneventful. Owners who do not describe it in other terms. Twenty minutes of administration against a year of quiet is a good trade.

Why does one account fail?

Because a single balance is a single number, and a single number gets spent against whatever is in front of it. Money that is not labelled behaves as though it were all available.

This is not a failure of discipline in any interesting sense. It is how money behaves when it is not labelled. An owner looking at one large balance and a renovation quote does not consciously decide to spend the tax reserve; they see a balance that covers the quote. The tax portion is spent months before anyone notices it is gone. Nobody decides to spend a tax reserve; they simply see a balance. An unlabelled balance is treated as though every dollar of it were free.

The correction is physical and not moral. Separate accounts, at a separate institution, with the tax portion in something that requires a deliberate step to reach. The friction is the feature. Friction is the point of the separation and not an inconvenience of it. An account that requires a separate login is an account that gets left alone.

There is a second reason worth naming. Proceeds sitting in an operating account change how the whole portfolio is assessed, including by you. Decisions get made on the basis of a balance that is mostly somebody else's money, and the decisions that get made in that month are the ones that are hardest to unwind. Decisions made in that month are the hardest ones to unwind later.

What about a purchase that is already lined up?

Then the sequence is tighter and the discipline matters more, and not less. A lined up purchase makes the sequence tighter and not looser.

An investor selling in order to buy has a deposit due, a closing date, and a tax bill that is now certain and not hypothetical. The temptation is to treat the whole deposit as purchase funds, on the reasoning that the tax is not due for months and the next property will produce income by then. Rent arrives monthly and a tax bill arrives in one piece. The new building will produce rent, and rent does not arrive in lumps.

That reasoning fails in a specific way. The new property produces rent, and rent funds carrying costs; it does not produce a lump equal to a tax bill on any useful timetable. An investor who deploys the tax portion into a purchase is financing the tax with next year's cash flow, and next year's cash flow was already spoken for. Financing a tax bill with next year's cash flow spends money that was already committed.

Where a purchase genuinely requires more than the uncommitted portion, the question is whether the purchase is the right size rather than whether the tax can wait. That is an unwelcome sentence and it is the one worth taking seriously. The size of the purchase is the variable that can still be changed.

What if the tax portion has already been spent?

Then it is a financing problem with a deadline, and there are four routes. None of the four is comfortable and all four are available.

Cash from the reserve, if the reserve is large enough, which is what the reserve exists for even though this is not the use anyone imagined for it. That is the use a reserve exists for, even when nobody pictured this version of it. Write the destination of each portion beside the amount, on the same page.

A draw on a secured facility, which is usually the cheapest borrowing available and is the ordinary answer where the facility exists and has room. A facility with room on it is the ordinary answer here.

A policy loan against a participating contract, where one exists and holds value, which is available on a written request without a credit decision. That is useful precisely when the file will not support a new application, and its limits are set out in what a policy loan cannot do for an investor.

Or an arrangement with the tax authority, which exists, has conditions, and carries interest. It is a real option and it is the one owners are most reluctant to explore, usually a year later than they should have. An arrangement with the tax authority is a real option and it is explored late far too often. Conditions and interest apply, and both are knowable in advance.

None of the four is free. All of them are cheaper than the fifth option, which is selling something else in a hurry. Every one of the four is cheaper than selling a second building in a hurry.

Where does the leftover belong?

Wherever capital with no date belongs, and that is a different question from this one. Uncommitted capital is a different question from a tax reserve, and it deserves its own answer. Uncommitted capital and a tax reserve are two different problems with two different answers.

Once the tax is set aside, the committed deposit is separated and the reserve is back to its full figure, what remains is genuinely uncommitted capital. The question of where that waits is the one the rest of this section answers, and it is set out attribute by attribute in where capital waits between properties.

Two cautions specific to a sale. The first is that a sale is the moment a portfolio has liquidity, and it is therefore the moment every idea gets proposed to the owner, including good ones at the wrong time. Nothing has to be decided that month. A month in which the account looks full is a poor month for permanent decisions.

The second is expensive debt. An investor carrying a consumer balance, a dealer plan or a drawn facility at a high rate has an answer available that beats every alternative on arithmetic, and it is unglamorous enough to be overlooked in a month when the account looks full. Expensive debt is the least exciting answer and often the correct one.

What should be written down?

Four lines, in the same file as the closing documents. Four lines, written on the day, and never reconstructed afterwards.

The closing date and the proceeds, because the year is decided by the first and the calculation starts from the second. Both numbers come straight off the closing statement. Both figures sit on the closing statement and neither has to be remembered.

The accountant's estimate of the tax, with the date it was produced and a note of what it assumed. Estimates made before the depreciation schedule is confirmed change, and knowing which one you are looking at matters in March. An estimate and a final figure are different documents and both are worth keeping.

Where each of the three portions went: the account, the institution, the maturity date of anything with one. An executor, a spouse or a future you will all need this, and none of them will reconstruct it from memory. Three destinations, three dates, and nothing left to memory.

And the decision about the uncommitted portion, or a note saying it has not been made yet. A decision deferred deliberately is a different thing from a decision avoided, and writing the sentence is what makes it the first one. A sentence written down is what turns a deferral into a decision. A note saying the decision is pending is itself a decision.

None of this is tax advice and the practice does not give tax advice. It is the sequence a CPA would recognise, written down so it happens in the right order.

Who this applies to

Every investor who sells a property, which over a long enough holding period is every investor. Hold long enough and every investor meets this page.

It applies with most force to an owner who claimed capital cost allowance throughout, because the recapture is the amount most often left out of a mental estimate and it is fully included in income. Recapture is the amount most often missing from a mental estimate.

It applies to an owner selling in the first half of a year, because the gap between the deposit and the due date is longest and the money has the most time to be absorbed. The longer the gap, the more the money has a chance to be absorbed.

It applies to an owner selling in order to buy, where the sequence is tightest and the pressure to use the tax portion is highest. The pressure to borrow from the tax portion is highest exactly there. Selling to buy is the tightest version of the whole sequence.

It applies less to an owner whose accountant already runs this process, and to an owner selling at a loss, where the arithmetic is different and other rules apply that belong to a CPA rather than to a page. The arrangement as a whole, including what happens if the portfolio is never sold at all, is described on the real estate investors page.