When marital relationships break down and the parties own property such as a matrimonial home or another real estate such as a cottage, part of the agreement about division of property should address potential tax consequences for transfers of property between spouses.
In the case of the matrimonial home, if that home is to be transferred from one spouse to the other as part of settlement, it is a fairly simple matter from the perspective of tax consequence as the titled spouse can transfer the matrimonial home to the other spouse without any tax consequence. The transferee, or person receiving the property, inherits the cost of the home for tax purposes from the transferor. In other words, if the transferor (the person transferring the property to the other spouse) paid $100,000 for the property, then that becomes the value of the property for the person receiving it (the transferee). If the recipient transferee continues to maintain that property as his or her principal residence, then capital gains for him or her on sale of that property at a later date will not be an issue. If, however, that property is not maintained as the principal residence of the recipient, the recipient may be subject to capital gains tax when they sell the property based on gains made above the $100,000 that was allocated as the inherited cost from the transferor at the time of transfer. The capital gain calculation is based on the amount of time that they did not reside in the home as their principal residence. There is a formula for this.
But that's not the only issue. Canada Revenue Agency has a rule called the "Attribution Rule." It is designed to avoid spouses transferring properties between themselves for tax benefit. Revenue Canada always wants to tax the highest income earner between spouses to maximize taxation. This rule may attribute income previously ascribed to a particular spouse without regard to the actual ownership of the property. That is to say, notwithstanding that one spouse might own the property that was transferred to him or her in a settlement, the income from that property, or the gain on its sale, might be attributed or allocated to the non-owning, transferring spouse for income tax purposes!
Obviously, this outcome for a transferor should be avoided, but it is not avoided automatically. When property is transferred pursuant to a written agreement or Order, it is usually assumed that any capital gain on the subsequent sale will belong to the recipient of the property. To ensure this result, however, both parties must be living separate and apart by reason of marriage breakdown, have not resumed cohabitation with the same year, and, they must sign a joint election whereby they agree not to have the capital gains attribution rules apply to any subsequent sale of the transferred property. This jointly-signed election must be filed by the transferring spouse with his or her personal income tax return for the taxation year in which the property was transferred. The election is usually signed by both parties upon execution of the written agreement giving rise to the transfer. There is, actually, no formal election form and this election agreement must be drafted specially for this purpose.
If the transferor of the property fails to complete this election, any capital gain arising from the subsequent sale of the transferred property by the Transferee spouse, could attribute back to the transferor if the parties are not yet divorced at the time of the sale to a third party, and if the transferor is the higher income earner. The election prevents this un-intended result which could have very significant tax consequences for the party transferring the property to a spouse as part of a settlement agreement.
Bryan Embree is an associate at the law firm of Cobb & Jones LLP