“Capital Gains? But I didn’t actually sell that." Deemed dispositions (Part 4 of Capital Gains Series)
- Elkhanagry Accounting
- Mar 5
- 7 min read
Updated: Mar 14
Table of Contents
Introduction
When Canadians think of capital gains tax, they usually associate it with selling an investment or property. However, what many taxpayers don’t realize is that the Canada Revenue Agency (CRA) can tax capital gains even when no actual sale has taken place. This is due to the concept of deemed dispositions under the Income Tax Act (ITA).
A deemed disposition occurs when the CRA treats you as having disposed of an asset, even if no actual sale or transfer occurred. This can have significant tax implications, as it may trigger an unexpected tax liability.
In this fourth installment of our Capital Gains Series, we’ll break down deemed dispositions, when they occur, their tax consequences, and relevant exemptions. We’ll also explore Section 69 of the ITA, which deals with non-arms length transactions, and highlight some key aspects of this section
What Are Deemed Dispositions?
A deemed disposition is a situation where the CRA considers a taxpayer to have disposed of an asset at its fair market value (FMV), even if no actual sale occurred. This, therefore, implies that for tax purposes there may be capital gains. The taxpayer may need to report and pay taxes on unrealized gains.
The Income Tax Act outlines various circumstances in which deemed dispositions occur.
Understanding deemed disposition rules is crucial to avoid unexpected tax liabilities and plan effectively for asset transfers, estate planning, and international relocation.
When Do Deemed Dispositions Occur?
1. Change of Use of Property – ITA Section 45(1)
A deemed disposition occurs when a taxpayer changes the use of a property from a principal residence to an income-producing property (e.g., rental property) or vice versa. This means the Canada Revenue Agency (CRA) considers the property as having been sold at fair market value (FMV) and immediately reacquired at FMV, even though no actual sale took place.
Tax Implications:
The taxpayer may realize a capital gain if the property has appreciated in value.
The principal residence exemption (ITA Section 40(2)(b)) may apply to reduce or eliminate the taxable capital gain if the property was a principal residence before conversion.
Election to Defer Capital Gains on Change of Use (ITA Section 45(2&3)) – If a principal residence is converted to a rental property, taxpayers can elect to defer gains (Will be explored in a later blog)
2. Departure from Canada – ITA Section 128.1(4) ("Exit Tax")
When an individual ceases to be a Canadian resident, they are deemed to have disposed of certain capital properties at FMV immediately before their departure. This is commonly known as the "departure tax."
Tax Implications:
A capital gain is triggered if the FMV of the property at departure is above its adjusted cost base (ACB).
The taxpayer is required to report this gain on their final Canadian tax return.
Certain properties, such as Canadian real estate and RRSPs, are not subject to the departure tax because they remain taxable in Canada.
Deemed Acquisition:
Once the individual leaves, the property is deemed reacquired at FMV, meaning this becomes the new cost base for future tax calculations.
3. Death of a Taxpayer – ITA Section 70(5)
When a taxpayer passes away, they are deemed to have disposed of all capital property immediately before death at FMV, triggering a potential capital gain or loss.
Tax Implications:
The deemed disposition can lead to a large capital gains tax liability, especially if the deceased owned investment properties, shares, or other appreciating assets.
Any unused net capital losses can be applied against all forms of taxable income in the year of death.
Spousal Rollover (ITA Section 70(6)& 73(1)):
If the property is left to a spouse or a qualifying spousal trust, the deemed disposition does not apply at death.
Instead, the property transfers to the surviving spouse at the deceased’s adjusted cost base (ACB), effectively deferring the capital gains tax until the spouse disposes of the property.
This is an automatic rollover. To have this not apply, the individual must elect out of this.
4. Trusts and the 21-Year Rule
Under ITA Section 104(4), most trusts are subject to a deemed disposition every 21 years.
Why the Rule Exists:
Trusts are often used for tax deferral and wealth preservation.
The 21-year rule prevents indefinite deferral of capital gains within a trust by forcing it to recognize unrealized capital gains at FMV every 21 years.
Tax Implications:
The trust must recognize capital gains on its assets as if they were sold.
This can create a significant tax liability for the trust.
5. Gifts & Transfers to Non-Arm’s Length Parties – ITA Section 69
(Explored in the next section in greater detail)
Section 69 ITA: Non-Arm’s Length Transfers
What happens if you sell property to a family member for less than FMV?
Section 69 of the ITA states that when property is transferred to a non-arm’s length party for less than FMV, the CRA deems the seller to have disposed of it at its full FMV. However, the recipient’s cost base remains at the actual transfer price, creating a potential double tax issue when they later sell the asset.
Example of Double Taxation in a Below-FMV Sale
John owns a house with an FMV of $500,000 but sells it to his son, Mark, for $1.
Under Section 69 ITA, the CRA deems John to have sold the house for $500,000, meaning he must pay capital gains tax on the gain from his original purchase price (e.g., if he originally bought it for $300,000, he will pay capital gains tax on $200,000).
However, Mark’s cost base is only $1, since that was the actual transfer price.
If Mark later sells the house for $600,000, he will owe capital gains tax on $599,999, even though John already paid tax on the increase in value up to $500,000.
This creates a double taxation issue—both John and Mark are taxed on the same appreciation of the property.
How to Avoid Double Taxation: Gifting Instead of Selling Below FMV
A more tax-efficient way to transfer property to a family member is to gift it outright. When a property is gifted:
The CRA still deems the transferor (giver) to have sold it at FMV, so capital gains tax may still apply.
However, the recipient (family member) receives the property with a cost base equal to the FMV at the time of transfer.
This ensures that when they eventually sell the property, they only pay tax on the increase in value from the date of the gift, rather than from the original purchase price.
Example of a Gifted Property Transfer
John gifts his house (FMV $500,000) to his son Mark.
The CRA still deems John to have sold the house at $500,000, so he must pay capital gains tax on any gain from his original purchase price.
However, Mark’s cost base is also $500,000, so if he later sells it for $600,000, he only pays capital gains tax on the $100,000 increase.
This avoids the double taxation trap where the recipient would have a lower cost base.
Income Tax Act References
This section deems a property to be disposed of at fair market value (FMV) when its use changes from a principal residence to an income-producing property or vice versa. This ensures that any accrued capital gains are taxed at the time of conversion, preventing indefinite tax deferral through property use changes.
When a taxpayer ceases Canadian residency, they are deemed to have disposed of their worldwide capital assets at FMV immediately before leaving. This prevents taxpayers from avoiding capital gains tax by emigrating without selling their assets, ensuring Canada collects tax on gains accrued while the individual was a resident.
Upon death, a taxpayer is deemed to have disposed of all capital property at FMV, triggering potential capital gains tax. This rule prevents indefinite tax deferral by ensuring accrued gains are taxed before assets transfer to heirs, unless an exemption applies (e.g., spousal rollover under Section 70(6)).
This section requires most trusts to recognize unrealized capital gains every 21 years as if assets were sold at FMV. It prevents trusts from being used to shelter capital gains indefinitely and ensures periodic taxation of accrued gains within trusts.
When property is transferred to a related party for less than FMV, the CRA deems the transfer to have occurred at full FMV for the seller, while the recipient's cost base remains at the actual transfer price. This prevents taxpayers from artificially lowering taxable capital gains through undervalued family transactions.
Contact Us!
Dealing with deemed dispositions can be overwhelming, whether it's triggered by changing a property's use, leaving Canada, estate settlements, trust taxation, or non-arms length transfers. These tax rules can result in unexpected liabilities, double taxation, and compliance challenges with the CRA.
At Elkhanagry Accounting, we specialize in:
✅ Assessing deemed disposition tax implications to ensure accurate reporting and minimize liabilities.
✅ Advising on capital gains tax exposure related to property conversions, emigration, and estate planning.
✅ Ensuring compliance with CRA rules on trust taxation, family transfers, and exit tax obligations.
Whether you're a homeowner, investor, expatriate, estate executor, or trustee, our team provides expert tax guidance tailored to your unique situation.
📞 Contact us today to schedule a consultation and safeguard your financial future!
Disclaimer
This article provides general information that is current as of the posting date and is not updated, which means it may become outdated. The content is not intended to provide accounting, tax, or financial advice and should not be relied upon as such. Tax and financial situations are unique to each individual and may differ from the examples discussed in this article. For personalized advice, please consult a qualified tax professional.
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