My question is: Canadian-specific QUESTION: Our principal residence includes 50 acres of land and so we will incurr capital gains when we sell. We do not have a mortgage. In calculating the capital gains is the amount owing on the mortgage subtracted from the gain before proceeding with the calculation? If that is the correct method of calculation then would it not be advantageous to anyone who owns their property outright to first get a mortgage on the place before selling? --------------------------------------------------------------------------- david ingram replies: If you did not farm the land and only bought 50 acres because you had to buy 50 acres because there were no smaller acreages and the zoning is 40 acres so that you cannot subdivide, the whole 50 acres might be tax free. If you could subdivide into 1/2 hectare (1.22 acre) lots, then 1.22 acres and the family house are tax free and you owe capital gains tax on the balance. If the zoning is a minimum of 10 acres, then the house and ten acres should be tax free and you would pay on the excess 40 acres. Putting a mortgage on the property will have no effect on the capital gains. The gain is the difference between what you paid (plus any improvements) for the property and what you sold it for. I have looked after a couple of hundred sales of land in excess of one acre tax returns and would be glad to walk you through this when the time comes whether by email, snail mail, fax or courier and phone. A phone consultation would be $350 Canadian. The actual tax return between $500 and $1,500 depending upon the rest of the information and how much background has to be done to establish the ACB, etc. The following is excerpted from the capital gains chapter of my old income tax book. You can find the whole chapter at: http://www.centa.com/taxguide/capital_gains.htm LAND IN EXCESS OF ONE ACRE In 1984, Carl Rudeloff lost his claim for a tax free sale of his home and ten acres which he had lived on and in for ten years. The Tax Review Board ruled that although the excess 9 acres of land certainly `contributed' to the use and enjoyment of his home, it was not necessary. The facts that the Rudeloff family had a woodlot, raised horses and chickens, had a family garden and a play area, did not sway Judge Taylor of the Tax Court of Canada. He said, "I am not persuaded the relevant section of the Income Tax Act permits of the view espoused by this taxpayer - that merely because he resided in a housing unit on the property, and used the balance of the property in one way or another to enhance the utility and attractiveness of that domestic living style, he can expand the boundaries of his housing unit to the parameters of the natural domain desired in his appeal." This last decision has been partially turned over in the 1991 Federal Court decision where Judge Strayer decided that an extra lot was not essential but certainly contributed to the use and enjoyment of the property. However, I find this ruling unusual for a country like Canada. Certainly, this country was built on small holdings, self-sufficiency, the raising of chickens and the growing of food in a garden. However, it seems that unless you can show that it was necessary for the use and enjoyment of a housing unit, it will not fly. Perhaps if he could have shown that he did not have enough money to feed his family, it would have proved `necessary'. I think I can explain it in other equally ridiculous terms, though. You buy a car with no doors or roof. It has an engine (necessary to use), a transmission (necessary to use), four wheels (necessary to use), a steering mechanism, (necessary to use), and brakes (but brakes are not necessary to use). Brakes, roofs, and doors are an example of things which certainly `add' to the use and enjoyment of a vehicle but are not necessary if you drive in a vacant and level field where it does not rain. Of course, if you want to drive down a hill, brakes would be necessary, but since you don't `HAVE TO' drive down the hill, they are not necessary. However, if you want to drive on a highway, THE LAW SAYS THAT BRAKES ARE NECESSARY. If it rains, you may say that a roof and doors (and windows) are necessary, but all sorts of people ride motorcycles in the rain with no doors, roof or windows. (Okay, okay, a windshield is really nice, but not necessary... my motorcycle does not have one). In fact, if any case should have been appealed to a higher court, the Rudeloff case should have been, and we at the CEN-TA GROUP had a similar case that was destined to "go to the top". We took our case to `the top' in 1988. Unfortunately, the Tax Court ruled against five members of the Cillis Family and they have decided not to appeal. But I still feel they should have won. Four generations of one family lived on five acres in two houses. They used the acreage for a riding ring (one son is now a full-time professional equestrian), duck ponds, swimming pool, barns, sheds, and wood lot for themselves. However, as the two houses had been legally subdivided `out' of the five acres, it was ruled that the excess land was not `necessary' for the `Use and Enjoyment'. And The Cillis family has decided not to appeal with good reason. DNR is treating this entire situation like parking meters. Either the violation flag is up or it is not. The courts have been interpreting the word "necessary" to mean "cannot be done without". I still feel that the Cillis Family would have won their case on appeal. You have not really lost until the final judge has had his or her say. Marianne Fourt found that out when she did not take "NO" for an answer. Sort of a reverse of the popular T-shirt which says, "What part of No don't you understand". In 1991, Marianne Fourt received a favorable ruling from the Federal Court Trial Division when the court ruled in favor of the tax free status of the second lot. The judge ruled that although not essential to the use and enjoyment of the family home, it clearly contributed to the use and enjoyment within the meaning of paragraph 54(g)(v) of the Act. She had lost in 1988 as stated below. In 1988, Marianne Fourt paid tax on an adjoining lot she sold. She bought two lots and built her home on one and used the second lot for an incinerator, storage shed and parking. Judge Goetz of the Tax court ruled that she could have built everything on one lot and the other was not necessary, i.e., could not be done without. It seems that unless, you have a "Yates" argument, i.e., could not have bought less because of zoning, you will not get anything more than one acre tax free. (to be fair, it is really 1.2 acres (1/2 hectare). Because of welfare, etc., the courts are determining that `eating off the land', i.e., garden, raising animals, etc., is not sufficient for necessity. In 1989, Elmer Augart won an unusual case when you consider some of the other cases previously mentioned. (Elmo Baird for instance). He had bought 8.99 acres and he lived on it for FOURTEEN YEARS BEFORE the land was rezoned to require 80 ACRES FOR A SINGLE FAMILY HOUSE. Judge Mogan of the Tax Court of Canada ruled that because of the YATES case mentioned before in the text, the entire 8.99 acres was necessary under section 54(g) of the Act. But also in 1989, the estate of Anna Lewis and the estate of John Lewis were taxed on the land in excess of one acre even though it was shown that the 2.11 acres could not be subdivided and sold as separate parcels. Judge Rip did not apply the Yates argument but he did change the values placed on the property by DNR resulting in a little less tax. The following cases just add to the argument and are here for your information. They include the YATES CASE. In 1983, Donald Fraser lost his claim for an extra half an acre used as a garden and play area. D. E. Taylor, member of the Tax Review Board, found that the taxpayer had failed to demonstrate the "necessity" for the garden and play area. In 1983, Elmo B. Baird, lost his bid for the tax-free sale of land in excess of one acre. Mr. Baird had bought 2.41 acres under the Veterans Land Act in 1951. He built outbuildings, raised farm animals, gardened, and used the size of the land for a septic field. Certainly "use", although an argument could be made by many "city dwellers" that tending a garden and cleaning stalls and septic fields is not "enjoyment", nor necessary. My understanding was that all VLA land was supposed to be in the 2 1/2 acres size `area'. If that is the case, Mr. Baird should have won his case because he could not have bought less land under VLA rules. In 1991, Glen Windrim paid tax on the value of some 15 acres of land. He had a mobile home on 17.6 acres for three years and when he sold them, he tried to claim the total tax free. However, he had only lived there three years and showed no evidence of use and enjoyment or necessity. It is interesting that DNR voluntarily gave him 2 hectares (4.6 acres) tax free and Judge Muldoon of the Federal Court Trial Division went along with it even though the act only allows 1/2 hectare (about 1.22 acres) and originally allowed only 1 acre. Interpretation bulletins IT 120 and IT 120R leave the impression that such matters as zoning will contribute to a favorable ruling when capital gains on land in excess of one acre are concerned. In the case of Mr. Baird, he could not legally have bought less than 2 1/2 acres (VLA financing not zoning rules), which is relevant when the next case is mentioned. The Famous Yates Case In 1983, William and May Yates won their case in The Federal Court - Trial Division. The taxpayers could not legally have occupied their residence without ten acres because of local zoning laws. It was necessary to have more than one acre. Even though they had rented the excess out to a farmer, they only sold the excess 9.3 acres under threat of having the area expropriated. Judge Mahoney ruled "The defendants could not legally have occupied their housing unit as a residence on less than ten acres. It follows that the entire ten acres, subjacent and contiguous, not only `may reasonably' be regarded as contributing to their use and enjoyment of their housing unit as a residence; it `must' be so regarded. It also follows that the portion in excess of one acre was necessary to that use and enjoyment." This case was appealed to the Federal Court of Appeal. I am pleased to say that In 1986, William Yates and his wife May Yates won again. Judges Heald, Stone and Ryan found for the Yates. But, there is a sense of futility here. When people need and use the land, they lose, but when they rent it out and don't use it, they win. In 1986, the estate of Sarah Raper won the tax free ownership of an extra 4 acres for 9 out of 10 years. Until 1980, zoning laws prevented the subdivision of the land into less than 5 acre plots. Even though she did not subdivide the land in 1980, Judge Tremblay of the Tax Court of Canada ruled that her lifestyle was not sufficient to show `necessity for use and enjoyment' after 1980, and assessed tax on the capital gain after 1980. He said that `use and enjoyment' should be decided on a year to year basis, thus giving credence to my graph in the tax books from 1974 to '82 wherein I suggest that a taxpayer should be able to designate alternate years or different years as tax free, rather than the successive years suggested by DNR. In 1987, John Wallace Beaton lost his case for the sale of 2.1 acres tax free showing again how the judge's mind works in these situations. In 1979 he had bought a `remnant' 4 acres in an area that required 25 acres to build a house. He built a house and drilled two wells, one on each half of the property. Neither well was satisfactory. In 1984 he sold 2.1 acres and kept the balance as his residence. He claimed the 2.1 acres was tax free because he needed it for his well and because of the zoning in place at the time of purchase. Judge Brule of the Tax Court of Canada ruled that it could not be said that Beaton could not have built on less than 4 acres as the land in question was already a remnant, and he certainly didn't need the extra 2.1 acres for his water supply because the well was unsatisfactory. The taxpayer was able to "do without" the 2.1 acres (i.e., he didn't need brakes.) In 1986, Jacob and Ruth Schellenberg won $221,000 out of a $375,000 sale as tax-free gains from the sale of their principal residence and an adjoining lot. DNR tried to reverse the figures to $154,000 for the principal residence, and $221,000 as taxable from the sale of the lot. Judge Christie of the Tax Court of Canada ruled that the Schellenberg's figures were correct. Hope this helps. You might try calling the Sunday radio program if you wanted more information free. Answers to this and other similar questions can be obtained free on Air every Sunday morning. Every Sunday at 9:00 AM on 600AM in Vancouver, Fred Snyder of Cartier Partners and I will be hosting an INFOMERCIAL but LIVE talk show called "ITS YOUR MONEY" Those outside of the Lower Mainland will be able to listen on the internet at www.600AM.com Local phone calls to (604) 280-0600 - This from ask an income tax immigration planning and bankruptcy expert consultant guru or preparer from www.centa.com or www.jurock.com or www.featureweb.com. 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