We are often asked by our clients how they should treat the carrying costs of vacant or undeveloped land for tax purposes. We are hopeful this blog will assist people to understand the appropriate treatment.

Background

Owners of vacant land incur carrying costs associated with ownership. Examples of such costs include property taxes, general maintenance and interest charges on debt used to acquire such property, among others. The accounting and tax treatment for such costs is not always obvious.

Vacant land can be divided into four broad categories:

  1. Vacant land held for redevelopment and sale;
  2. Vacant land used in a business;
  3.  Vacant land rented to third parties; or
  4. Other vacant land.

Carrying costs are treated differently depending which category applies to the subject land.

Vacant Land Held for Development and Sale

A taxpayer may hold a piece of land with the intention of flipping the land for a profit or the construction of buildings or other development which the taxpayer intends to re-sell, presumably for a profit.

In such cases, the vacant land is considered a form of inventory.

For accounting purposes, the costs are deferred until the sale of the land. The taxpayer should record the purchase price and all carrying costs as a form of inventory on its balance sheet. Upon sale, the deferred costs are written off against the sale proceeds.

For tax purposes, the proceeds from the sale of the land are considered business income and the carrying costs should be deductible as part of the cost of bringing the land to its sale condition. The deduction for carrying costs occurs at the time of sale. If the development activity happens over a number of years, the carrying costs are deferred and deducted against the sale proceeds in the year of sale.

In other words, if the taxpayer is properly accounting for the carrying costs, the accounting and tax treatment are the same.

An incorporated taxpayer may be entitled to an annual “base level deduction” which will accelerate the tax deductibility of the carrying costs. The application of the base level deduction is restricted to certain development corporations and is beyond the scope of this article.

Vacant Land Used in a Business

A taxpayer may own a piece of land for use in a related business. For example, a trucking company might purchase a piece of land to store its vehicles, or a lumber mill might own a piece of land on which to sort and store its logs or wood chips.

For accounting purposes, the carrying costs of the land should be deducted against business income as they are incurred. For tax purposes, the carrying costs should be deductible against business income as they are incurred. In other words, if the taxpayer is properly accounting for the carrying costs, the accounting and tax treatment are the same.

Vacant Land Rented to Third Parties

A taxpayer may hold vacant land for the purpose of renting the land to third parties.

For accounting purposes, the carrying costs of the land should be deducted against the rental income.

For tax purposes, the carrying costs are deductible, provided the land is held primarily for the purpose of earning rent from the land.

Other Vacant Land

This category includes any vacant land that does not fit into the other three categories. The owners may be uncertain about their intentions with the land or may see the land as a long-term store of wealth. Or the use may be purely personal in nature.

If the primary purpose of holding the land is not to earn rents, then the deduction of property taxes and loan interest is restricted to the amount of rental income received.

If the land is purely personal in nature, the carrying charges are never deductible.

If the intentions of the owner are uncertain, the land may be inventory or capital property. CRA’s presumption is that land is an inventory property unless the taxpayer can prove that it is a capital property.

In either case, the carrying cost are not deductible as they are incurred but may be deductible in the future at the time of sale.

This implies that the taxpayer needs to keep detailed records of the non-deductible portion of carrying costs in case they become deductible against the land sale proceeds in the future.

Conclusion

The treatment of carrying cost on vacant or undeveloped land is dependent upon the facts of the situation. Keep good records and, when in doubt, seek the help of a professional.

 

Written by: Doug Johnstone, CPA, CA

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