Capital Gains Reserve When You Sell Property With a Mortgage Back

If you sell a property and agree to take back a mortgage from the buyer, you may not receive all of your money at closing. Yet the gain is usually calculated for the year of sale. Many sellers ask whether they can spread the tax over several years.

A capital gains reserve may let you do that. This article explains in plain language how it generally works, what limits apply, and what to discuss with your accountant or lawyer before you agree to a take-back mortgage.

What the reserve does

A capital gains reserve lets you hold back part of your gain when some of the sale proceeds are not yet due. It can generally be claimed for up to four years, so the gain is included over five years.

Under subsection 44(1) of the Income Tax Act, the reserve for proceeds not yet due is limited by a five-year rule, and at least one-fifth of the gain is brought into income each year. So even if the mortgage runs for longer, you cannot defer the full gain beyond that schedule.

Why it matters with a vendor take-back mortgage

With a vendor take-back mortgage, part of the price is paid to you over time. The gain is still the proceeds minus your adjusted cost base and selling outlays. Proceeds of disposition are usually the amount you received or are to receive, which is why the unpaid balance can be part of the proceeds in the year of sale.

The reserve is the tool that matches tax to the money coming in. Whether it applies to your deal, and how much you can claim, depends on the terms of your mortgage and the facts of your sale, so confirm with an accountant or lawyer.

How long the reserve can run

The nine-year period is limited, so do not assume it applies to an ordinary house, condo or rental property.

When you cannot claim a reserve

A reserve generally cannot be claimed in certain situations.

• You were not a Canadian resident, or were exempt from tax, at the end of the year or at any time in the following year.
• You sold the property to a corporation that you control.
• The amount you claim in a later year would exceed the prior year's claim for that property.

Also, the reserve is for capital gains. If a sale is treated as business income, such as a flip of a housing unit held for less than 365 consecutive days, it is deemed not to be capital property. In that case, the capital gains reserve may not be the right tool, so get advice.

How the reserve is claimed

You use Form T2017 to claim the reserve, and its line 31 amount goes on line 19200 of Schedule 3. If the property was a rental, its disposition is listed on Schedule 3. For rental property, land and building are reported separately.

The reserve is not a one-time step. Each year during the reserve period you work out the amount again, and the minimum one-fifth inclusion means part of the gain will come into your income each year.

What to do next

• Before agreeing to a take-back mortgage, ask your accountant to estimate the gain and the yearly inclusion.
• Confirm that the buyer is not a corporation you control.
• Check your residency status for the year of sale and the following year.
• Keep your adjusted cost base records and selling-cost invoices.
• Have your lawyer review the mortgage terms, including the payment schedule, since the reserve depends on when proceeds are due.
• Diarize the T2017 and Schedule 3 reporting for each year of the reserve.

Frequently asked questions