It is one of the most common pre-sale moves in Canada: the owner keeps the building, sells the business, and leases the premises back to the buyer. It solves a real problem and it creates three others that rarely get priced. Here is what the carve-out triggers, and the one exclusion in the GST/HST rules that catches exactly this structure.
Key takeaways
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Two motivations, usually at once. The first is simple: the owner wants to keep the building, either as a retirement asset or because they believe it will appreciate faster than anything they would do with the sale proceeds.
The second is structural. Real estate that is not used principally in the active business is exactly the kind of asset that counts against the tests governing whether shares qualify for the lifetime capital gains exemption. Under Income Tax Act s. 110.6, the definition requires that through the 24 months before the sale, more than 50% of the fair market value of the corporation’s assets was attributable to assets used principally in an active business carried on primarily in Canada.
A building the company owns and operates from is generally on the right side of that. A building it owns and rents out, or holds beyond its needs, is the classic problem asset — the specific question Treadstone Law addresses in whether non-active assets push you over the purification threshold.
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This is the part that surprises owners, because the transaction feels like housekeeping rather than a sale. Moving property out of a corporation to its shareholder is a disposition, and a disposition at fair market value realises the accrued gain.
On a building held for twenty years in an appreciating market, that gain can be substantial — and there is no cash from a purchaser to fund the tax, because nobody has bought anything yet. The carve-out done to improve the tax outcome of the sale can generate a tax bill before the sale happens.
A rollover under Income Tax Act s. 85 is the usual mechanism for moving property without an immediate gain, but it has its own conditions — eligible property, a taxable Canadian corporation, consideration that includes shares of that corporation, and a joint election in prescribed form. A transfer to the shareholder personally is not the same transaction as a transfer to a corporation.
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The asset test looks back 24 months. Removing a problem asset today does not retroactively change what the balance sheet looked like last year.
So a carve-out executed to fix a qualification problem has to happen far enough ahead of the sale that the corrected position has actually been held for the required period. Executed in the month before closing, it can cost tax without buying the benefit it was intended to buy.
That is the single most important scheduling point in this whole area, and it is why the carve-out conversation belongs with the exit-planning conversation rather than with the closing checklist.
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Having kept the building, the owner leases it to the buyer, and everyone assumes the transaction’s GST/HST election covers the arrangement. It does not.
Excise Tax Act s. 167(1.1) sets out what the election does, and expressly excludes three categories: “(i) a taxable supply of a service that is to be rendered by the supplier, (ii) a taxable supply of property by way of lease, licence or similar arrangement, and (iii) where the recipient is not a registrant, a taxable supply by way of sale of real property”.
The second exclusion describes a sale-and-leaseback carve-out precisely. Property supplied by way of lease is outside the relief, and an owner who has structured the deal to keep the building has structured themselves into that exclusion.
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Two further mechanics are worth knowing before relying on the election at all. The joint election under s. 167(1)(b) is available “except where the supplier is a registrant and the recipient is not a registrant” — which is a live issue where the buyer is an individual or a newly-formed entity that has not yet registered.
And the filing is time-limited. Where the recipient is a registrant, the election must be filed with the Minister no later than the day its return is due for the first reporting period in which the tax would otherwise have become payable. Missing it is not a paperwork problem that can be tidied up later.
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Moving real property triggers land transfer tax in most Canadian jurisdictions, calculated on the value of the consideration. It is a transaction cost of the carve-out itself, entirely separate from income tax, and it does not care that the transfer was internal.
On a commercial property it is a real number rather than a rounding error. Treadstone Law sets out the Ontario calculation in how land transfer tax is calculated, and the arithmetic is worth doing before the decision rather than after it.
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A buyer looking at a business whose premises have just been moved into the seller’s personal name is being asked to accept a landlord with whom they have no other relationship, on a lease that did not exist during diligence.
The lease terms then become a deal point of their own: length, renewal rights, rent review, what happens if the buyer wants to move. A short lease on a purpose-built facility is a genuine risk to the business the buyer is purchasing, and they will price it.
The related question of whether a buyer can insist on a particular treatment is covered by Treadstone Law in whether a seller can be forced to carve out a piece before a share sale, and from the seller’s side in whether a seller can carve out real estate and keep it personally.
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A carve-out removes value from the company. If the company has obligations — bank debt secured on the property, guarantees, trade creditors, an underfunded liability — taking an asset out can leave it unable to meet them.
That is a different category of problem from an unexpected tax bill, and it can attract remedies rather than just a cost. Treadstone Law deals with the scenario directly in a carve-out that leaves the seller’s company unable to pay its debts.
Secured lenders will also have a view, and usually a contractual right to one. A building charged to a lender is not the shareholder’s to move simply because they own the company.
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Start with the timing, because it is the only input that cannot be fixed later. If the exit is more than two years away, a carve-out can genuinely improve the qualification position. If it is imminent, the tax cost is real and the qualification benefit may not arrive in time.
Then price all four costs together rather than one at a time: the gain on the transfer, land transfer tax, the GST/HST that the election will not relieve on the lease, and whatever the buyer deducts for taking a lease from a related landlord.
Owners routinely evaluate the first of those and discover the other three afterwards. All four are knowable in advance, and together they sometimes change the answer.
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