Roll-over relief

Roll-over relief is a tax deferral mechanism that allows businesses to defer capital gains tax on the sale of an asset if the proceeds are reinvested in a similar asset.
By:
Updated: Jun 11, 2024

3 key takeaways

Copy link to section
  • Roll-over relief enables businesses to defer capital gains tax by reinvesting the proceeds from the sale of an asset into a new qualifying asset.
  • The relief is designed to encourage businesses to reinvest in their operations without facing immediate tax liabilities.
  • The deferred capital gain is deducted from the cost basis of the new asset, effectively postponing the tax liability until the new asset is sold.

What is roll-over relief?

Copy link to section

Roll-over relief is a tax incentive that allows businesses to defer paying capital gains tax on the sale of certain business assets if the proceeds from the sale are reinvested in similar assets. This relief helps businesses manage their cash flow and continue investing in their operations without the immediate burden of a tax liability.

The principle behind roll-over relief is that the capital gain realized from the sale of an asset is “rolled over” into the new asset, thereby deferring the tax on the gain until the new asset is sold. This can be particularly beneficial for businesses that need to replace or upgrade their assets regularly.

How does roll-over relief work?

Copy link to section

Roll-over relief operates by deferring the capital gains tax that would otherwise be payable on the sale of a qualifying asset. The process involves the following steps:

Qualifying assets

Copy link to section

To be eligible for roll-over relief, both the asset being sold and the asset being purchased must qualify under the specific tax regulations. Common qualifying assets include business property, machinery, and equipment.

Reinvestment period

Copy link to section

The proceeds from the sale of the asset must be reinvested in a new qualifying asset within a specified period, typically within one to three years. This reinvestment period is defined by tax authorities and may vary by jurisdiction.

Deferral of capital gain

Copy link to section

The capital gain from the sale of the original asset is deferred by deducting it from the cost basis of the new asset. This means that the tax on the gain is postponed until the new asset is sold.

The deferred gain reduces the base cost of the new asset, potentially resulting in a higher taxable gain when the new asset is eventually sold.

Example calculation

Copy link to section

Consider a business that sells a piece of machinery for $100,000, realizing a capital gain of $30,000. If the business reinvests the $100,000 into a new piece of machinery within the allowable period, the $30,000 gain is deferred.

The cost basis of the new machinery is reduced by the deferred gain, making the new cost basis $70,000. The capital gains tax on the $30,000 gain is deferred until the new machinery is sold.

Importance of roll-over relief

Copy link to section

Roll-over relief is an important tax incentive for businesses, offering several benefits:

Encourages reinvestment

Copy link to section

By deferring the capital gains tax, roll-over relief encourages businesses to reinvest in their operations. This reinvestment can lead to increased productivity, growth, and competitiveness.

Improves cash flow

Copy link to section

Deferring the capital gains tax helps businesses manage their cash flow more effectively. Instead of paying the tax immediately, businesses can use the full proceeds from the sale of an asset to invest in new assets.

Supports business growth

Copy link to section

Roll-over relief supports business growth by enabling companies to upgrade or replace assets without the immediate burden of a tax liability. This can be particularly beneficial for businesses in capital-intensive industries.

Benefits and limitations of roll-over relief

Copy link to section

Understanding the benefits and limitations of roll-over relief provides insight into its practical implications for businesses.

Benefits

Copy link to section
  • Tax deferral: Roll-over relief allows businesses to defer capital gains tax, improving cash flow and enabling reinvestment in operations.
  • Encourages reinvestment: The relief incentivizes businesses to reinvest proceeds from asset sales into new qualifying assets, promoting growth and modernization.
  • Flexibility: Roll-over relief provides flexibility in managing tax liabilities, allowing businesses to plan their finances more effectively.

Limitations

Copy link to section
  • Strict eligibility criteria: Both the sold and purchased assets must meet specific criteria to qualify for roll-over relief, which can limit its applicability.
  • Reinvestment period: The proceeds must be reinvested within a defined period, which may not always align with a business’s investment timeline.
  • Deferred tax liability: While the capital gains tax is deferred, it is not eliminated. The deferred gain is deducted from the cost basis of the new asset, potentially leading to a higher tax liability when the new asset is sold.

Examples of roll-over relief in practice

Copy link to section

To better understand roll-over relief, consider these practical examples that highlight its application in different contexts:

Example 1: Manufacturing business

Copy link to section

A manufacturing business sells an old piece of machinery for $200,000, realizing a capital gain of $50,000. The business reinvests the entire $200,000 in new machinery within the allowable period.

The $50,000 gain is deferred, reducing the cost basis of the new machinery to $150,000. The capital gains tax on the $50,000 gain is deferred until the new machinery is sold.

Example 2: Real estate company

Copy link to section

A real estate company sells a commercial property for $1 million, realizing a capital gain of $200,000. The company reinvests the proceeds in a new commercial property within the reinvestment period.

The $200,000 gain is deferred, reducing the cost basis of the new property by the same amount. The capital gains tax on the deferred gain is postponed until the new property is sold.

Example 3: Farming business

Copy link to section

A farming business sells a piece of agricultural equipment for $50,000, with a capital gain of $10,000. The business reinvests the proceeds in new equipment within the specified period.

The $10,000 gain is deferred, reducing the cost basis of the new equipment. The deferred tax liability is postponed until the new equipment is sold.

Roll-over relief is a valuable tax deferral mechanism that supports business reinvestment and growth. If you’re interested in learning more about related topics, you might want to read about capital gains tax, tax deferral strategies, and investment planning. 



Sources & references
Risk disclaimer
Arti
AI Financial Assistant
Arti is a specialized AI Financial Assistant at Invezz, created to support the editorial team. He leverages both AI and the Invezz.com knowledge base, understands over 100,000... read more.