How is a vendor take-back taxed?

A vendor take-back means the seller finances part of the purchase price. The buyer pays some cash at closing and signs a promissory note for the rest. It is common in small and mid-market Canadian deals because it bridges a valuation gap and helps a buyer who cannot fund the whole price. It also changes when the seller pays tax — sometimes helpfully, sometimes not.

The capital gains reserve spreads the gain

Ordinarily, the full capital gain on a sale is realized in the year of the sale, even if you have not been paid. The capital gains reserve is relief from that. Where an amount of the proceeds is not due until a later year, you may generally claim a reserve for the portion not yet receivable, and bring it into income as the payments become due. Practically, this spreads the gain over the payment period and can keep you out of the top bracket in a single year.

The reserve has hard limits

• A minimum fraction of the gain must generally be brought into income each year, which caps how long the spreading can last.
• The maximum reserve period is set by statute and is longer for certain transfers of shares or farm and fishing property to a child or grandchild than for an ordinary arm’s-length sale.
• The reserve generally applies to capital gains, not to income items such as inventory or recapture of capital cost allowance in an asset sale.
• You must be resident in Canada and claim the reserve properly on your return; it is elective, not automatic.
• Confirm the current fractions and year limits with the CRA — they are legislated figures and should not be assumed.

Interest is taxed separately and less kindly

Interest earned on the vendor note is ordinary income, taxable in full as it accrues, not a capital gain. That means the interest component of a vendor take-back is taxed at a higher effective rate than the principal component under a reserve. Sellers sometimes negotiate a higher price with a lower interest rate for this reason, but pricing that is not neutral — the CRA can look at whether the split reflects commercial reality, and the buyer has the opposite preference because interest is generally deductible to them.

The risk that the money never arrives

A reserve defers tax on money you have not yet collected, which is helpful. But if the buyer defaults, you may face a gain already partly recognized and a debt you cannot collect. There are rules that can provide relief for bad debts on a disposition, but they are technical and rarely make you whole. Security matters: personal guarantees, a general security agreement, a share pledge, and clear default remedies in the note.