Chris asked:

I plan to form a partnership in Nova Scotia Canada with some friends.

We will each contribute to buy a property - 30 acres in NS which we will then sub divide. Property purchase price = C$500,000.

I will contribute $50,000 and receive two lots each of which already has a house built on it. The likely assessed value these lots (by county tax assessor) after the subdivision will be $300,000. (My partners view extra value in these lots as my finders and management fees)

The other partners will contribute C$200,000 each and receive 4 lots each, each lot having cost to them C$50,000. Each likely having a tax assessed value of $20,000.

From my understanding the difference between the tax basis of the lots I receive - C$300,000 less $50,000 = $250,000 would be considered ordinary income. If I were to then hold onto the lots for a period of time and then sold them for say $500,000 the $200,000 (Sale price less tax basis) would be considered capital gain.

My questions

1) Am I correct assuming that all the profit (i.e. sale of a lot for greater than $50,000) each partner other than myself receives will be treated as capital gain? My logic is that even though the tax assessor may have valued them at $20,000 the partner actually paid $50,000 and therefore capital gains is only paid on anything over $50,000.

2) What is the capital gains tax rate, none of the partners are Canadian residents ­ is it 75% of the gain taxed at 50% of the minimum tax rate? ­ If so what is the rate ­ 44%?

3) In my case am I correct in assuming the $250,000 will be treated as ordinary income and if I am correct when would the tax be due, immediately or only when and if I sell the lots. Is the income deemed deferred until I actually received it in cash?

4) Is a partnership the best way to go?

Karen Yull answered:

Some assumptions must be made to provide an answer to this question. Although it is noted that the purchase price of this property is $500,000, one individual will contribute $50,000 and the other two will contribute $200,000 each, for a total of $450,000.

I have made the following assumptions:

• the FMV of the property is $450,000;
• tax assessed value is not necessarily representative of fair market value;
• each vacant lot has fair market value of $30,000
• the lots with a residence each have a FMV of $105,000
• the three non-resident individuals who are purchasing the property are dealing with each other at arm's length.

To answer the question, it is necessary to determine the FMV of the share of property acquired by each person. This will represent the tax cost of their interest in the property. Although values will change once the property is severed, to simplify matters I have assumed that the tax cost of the property will be allocated as follows:

• Person A $210,000 (contributed $50,000)
• Person B $120,000 (contributed $200,000)
• Person C $120,000 (contributed $200,000)

Capital gain

Therefore, one person (person A) has only contributed $50,000 for a property with a FMV of $210,000. The difference appears to be due to the fact that he or she is receiving a finders/management fee. There are really two transactions taking place - a purchase of property in Canada and the payment of a fee to a non-resident for services rendered. Persons B & C have remunerated person A for his or her efforts by contributing more than FMV for their lots - they could have achieved the same result by paying FMV for their lots (i.e. $120,000 each) and giving person A the difference (i.e. $80,000 each), so person A could invest in the property. Therefore, based on the above assumptions, person A is receiving $160,000 as a finders/management fee.

Such amount would be taxable as ordinary income if the person was a resident of Canada. Since the person is a non-resident of Canada, the tax laws of that country and any applicable Tax Treaty would have to be reviewed. The reporting of this income could not be deferred until the lots were sold since it has, in effect, been indirectly received by person A.

Rates

Assuming the investment was not a business or an adventure in the nature of trade, a sale of the property in the future would be taxed as a capital gain. If person A sold the two lots for $500,000 (assuming a tax cost of $210,000 under the above scenario) he or she would report a capital gain of $290,000. Similarly, persons B & C would report a capital gain to the extent each lot was sold for more than $30,000 each.

However, only 50% of the capital gain would be subject to tax. Therefore, assuming a $290,000 capital gain, the taxable capital gain would be $145,000. The current rate of tax for a non-resident individual on this gain would be calculated using graduated federal tax rates and a flat 48% non-resident tax (i.e. 48% of the federal tax). I'm not sure what the 44% refers to. It could be a reference to a corporate tax rate. However, corporations are also only taxed on 50% of the gain.

Partnership

I'm not sure that a partnership would be the best way to go. Based on what they intend to do with the property, it may not really be a "partnership" (as a partnership generally implies the carrying on of a business).

Also, partnerships are subject to special tax rules that must be followed - for example, each partner does not acquire the property directly, but an interest in the partnership. The partnership owns the property. In this situation, it would likely be better to acquire the property as a joint venture (this is somewhat different than a partnership), although other options are available.

About the author

 
Click here to go back to Ask-an-Expert index page.