Property transfers often create significant income tax issues and can be either errors of commission or errors of omission. Over my 25 years as an accountant, I have been referred some unbelievably messed up situations involving intra-family transfers of property.
Know the tax implications of transferring properties
Transfers: Why They Are Undertaken?
Many individuals transfer capital properties (real estate and common shares, being the most common) in and amongst their families like hot cakes. Some of the reasons for undertaking these transfers include: (1) the transferor has creditor issues and believes that if certain properties are transferred, the properties will become creditor protected (2) the transferor wishes to reduce probate fees on his or her death and (3) the transferor wishes to either gift the property, transfer beneficial title or income split with lower-income family members.
I will not discuss the first reason today because it is legal in nature. But be aware, Section 160(1) of the Income Tax Act can make you legally responsible for the transferor’s income tax liability and there may be fraudulent conveyance issues amongst other matters.
Transfers of Property – Income Tax Implications
When a property is transferred without consideration (i.e., as gift or to just transfer property into another person’s name), the transferor is generally deemed to have sold the property for proceeds equal to its fair market value (FMV). If the property has increased in value since the time the transferor first acquired the property, a capital gain will be realized and there will be taxes to be paid even though ownership of the property has stayed within the family. For example, if Mom owns a rental property worth $500,000 which she purchased for $100,000 and she transfers it to her daughter, Mom is deemed to have a $400,000 capital gain, even though she did not receive any money.
There is one common exception to the deemed disposition rule. The Income Tax Act permits transfers between spouses to take place at the transferor’s adjusted cost base instead of at the FMV of the capital property.
This difference is best illustrated by this example: Mary owns shares of Bell Canada, which she purchased 5 years ago at $50. The FMV of the shares today is $75. If Mary transferred the shares of Bell Canada to her brother, Bob, she would realize a capital gain of $25. If instead Mary transferred the shares of Bell Canada to her husband, Doug, the shares would be transferred at Mary’s adjusted cost base of $50 and no capital gain would be realized. It must be noted that if Doug sells the shares in the future, Mary would be required to report the capital gain realized at that time (i.e. the proceeds Doug receives from selling the shares less Mary’s original cost of $50) and Mary would be required to report any dividends received by Doug on those shares from the date of transfer.
When transfers are made to spouses or children who are minors (under the age of 18), the income attribution rules can apply and any income generated by the transferred properties is attributed back to the transferor (the exception being there is no attribution on capital gains earned by a minor). The application of this rule is reflected in that Mary must report the capital gain and any dividends received by Doug. If the transferred property is sold, there is often attribution even on the substituted property.
We have discussed where property is transferred to a non-arm’s length person that the vendor is deemed to have sold the property at its FMV. However, what happens when the non-arm’s length person has paid no consideration or consideration less than the FMV? The answer is that in all cases other than gifts, bequests and inheritances, the transferees cost is the amount they actually paid for the property and there is no adjustment to FMV, a very punitive result.
In English, what these last two sentences are saying is that if you legally gift something, the cost base and proceeds of disposition are the FMV. But if, say, your brother pays you $5,000 for shares worth $50,000, you will be deemed to sell the shares for $50,000, but your brother’s cost will now only be $5,000, whereas if you gifted the shares, his cost base would be $50,000. A strange result considering he actually paid you. This generally results in “double taxation” when the property is ultimately sold by the transferee (your brother in this case), as you were deemed to sell at $50,000 and your brothers gain is measured from only $5,000 and not the FMV of $50,000.
Transfers of a Principal Residence – The Ultimate Potential Tax Nightmare
I have seen several cases where a parent decides to change the ownership of his or her principal residence such that it is to be held jointly by the parent and one or more of their children. In the case of a parent changing ownership of say half of their principal residence to one of their children, the parent is deemed to have disposed of the property. This initial transfer is tax-free, since it is the parent’s principal residence. However, a transfer into joint ownership can often create an unforeseen tax problem when the property is eventually sold. Subsequent to the change in ownership, the child will own the principal residence.
When the property is eventually sold, the gain realized by the parent on his or her half of the property is exempt from tax since it qualifies for the principal residence exemption; however, since the child now owns half of the property, the child is subject to tax on any capital gain realized on their half of the property (i.e. 50 per cent of the difference between the sale price and the FMV at the time the parent transferred the property to the child, assuming the child has a principal residence of their own).
Many people are far too cavalier when transferring property among family members. It should be clear by now that extreme care should be taken before undertaking any transfer of real estate, shares or investments to a family member. I strongly urge you to consult with your accountant or to engage an accountant when contemplating a family transfer or you may be penny wise but tax foolish.
Max Goodfield is a Chartered Professional Accountant and blogger for The Blunt Bean Counter. That’s where he shares his thoughts on income taxes, finance and the psychology of money.
This is an edited version of an article that was originally published for subscribers in the October 2022, issue of The Taxletter. You can profit from the award-winning advice subscribers receive regularly in The Taxletter.
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The TaxLetter •11/20/22 •