Do I Qualify?
- You sold capital property (real estate, shares, farmland, etc.) at a gain
- The buyer owes you proceeds that have not yet been received — you are receiving payment over more than one year (e.g., via a vendor-take-back mortgage or installment agreement)
- The property is not inventory (business stock-in-trade doesn’t qualify)
- You are a Canadian resident for tax purposes
What Is It?
When you sell property at a capital gain and receive the purchase price over several years, the capital gains reserve under the Income Tax Act (ITA s.40(1)(a)(iii)) lets you defer the portion of the gain that corresponds to unpaid proceeds. Instead of reporting the entire gain in the year of sale, you report it gradually — proportional to the amounts you actually receive each year.
The maximum reserve period is 5 years for most capital property. For farm or fishing property sold to a child (or grandchild, in some circumstances), the reserve can extend to 10 years, giving farmers a powerful succession-planning tool.
How It Works
The Basic Calculation
Each year, you must include in income the greater of:
- The proportional amount: Total capital gain × (proceeds received to date ÷ total proceeds)
- The minimum annual inclusion: At minimum, you must include 1/5 of the original gain each year (or 1/10 for the extended reserve), so the full gain is reported within 5 (or 10) years even if you haven’t received all the money yet
Example: You sell a rental property for $500,000, with an ACB of $200,000. Total capital gain: $300,000. The buyer pays $100,000 at closing and $80,000/year for five years.
- Year 1: Proceeds received = $100,000 (20% of $500,000). Reserve = 80% × $300,000 = $240,000. Taxable gain year 1 = $60,000. Taxable capital gain (50% inclusion) = $30,000.
- Year 2: Proceeds received = $180,000 (36% of $500,000). Prior year’s reserve ($240,000) is brought back into income. New reserve = 64% × $300,000 = $192,000. And so on.
Form T2017
You claim and calculate the reserve on CRA Form T2017 — Summary of Reserves on Dispositions of Capital Property, which is attached to your T1 return each year until the reserve is fully used up.
The 10-Year Reserve for Farm and Fishing Property
If you sell qualified farm property or qualified fishing property to a child (including stepchild, adopted child, or grandchild), the reserve period extends to 10 years under ITA s.40(1.1). This must be an arm’s-length transfer to a child who will actively carry on the farming or fishing business. The minimum annual inclusion drops to 1/10 of the total gain per year.
Interaction with the Lifetime Capital Gains Exemption (LCGE)
If you claim the Lifetime Capital Gains Exemption (LCGE) on a sale of qualified small business corporation shares or qualified farm/fishing property, you can claim the LCGE in the year of sale against the full gain — then use the reserve to defer the remaining taxable gain. The LCGE applies first, reducing the taxable gain to zero or near zero, and any remaining gain is spread via the reserve. This combination is one of the most powerful tax-reduction strategies available to Canadian business owners and farmers.
What Most People Don’t Know
- You cannot claim more reserve than makes sense. If proceeds received exceed the proportion that would support the reserve, you must include the excess gain that year. You cannot artificially slow down your inclusion if you’ve been paid a large lump sum.
- If the buyer defaults, you can recapture the reserve. If you repossess the property after default, you report any capital gain corresponding to the proceeds you actually received to date; unreceived proceeds don’t create income.
- The reserve is optional. You can choose not to claim it and report the entire gain in the year of sale — sometimes preferable if you have capital losses to offset.
- Year of death rule. If you die while carrying a reserve, the reserve is fully included in your terminal return income — there is no further deferral beyond the year of death.
- The 5-year limit is firm for non-farm property. Unlike the US instalment sale rules, which have no time limit, Canada’s reserve expires at 5 years. If the sale extends beyond 5 years, you will have fully reported the gain even if you haven’t received all the proceeds.
Frequently Asked Questions
Can I use the capital gains reserve for shares in a private company?
Yes, provided the shares are capital property (not inventory). The reserve applies to any capital property, including shares. If the shares are qualified small business corporation shares and you claim the LCGE, you can still use the reserve for any remaining gain after the LCGE is applied.
What is “qualified farm property” for the 10-year reserve?
Broadly, it includes farmland, farming quota, and shares or partnership interests in family farming operations, provided the land or business was principally used in farming in Canada. The CRA’s definition under ITA s.110.6 requires that the property be used in farming by you, your spouse, your child, or a family farming corporation. A farm sold to a child must be used by that child to carry on farming.
How do I report the reserve on my tax return?
Use CRA Form T2017 (Summary of Reserves on Dispositions of Capital Property). Attach it to your T1 each year you are carrying a reserve. Your accountant or tax software will guide you through the annual in-and-out calculation: the prior year’s reserve is brought back into income, and a new reserve is claimed based on outstanding proceeds.
Does the reserve apply to selling a principal residence?
No. The principal residence exemption eliminates the capital gain entirely, so there is no gain to spread. The reserve is only relevant when you have a taxable capital gain on the sale.
What happens if I structured a vendor-take-back mortgage and the buyer pays off the loan early?
If the buyer pays the remaining balance early, you receive all the proceeds in that year. You must report the full remaining reserve as income in the year of early payment — you cannot continue deferring a gain when the proceeds have been received.