18 July 2007 External T.I. 2007-0242921E5 - remainder interest in A's prin res held by B

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: 1. In computing the eventual gain on property held by a child where the parent transferred a remainder interest in that property to the child prior to death, is the child's ACB of the property based on the fair market value of the property at the time the remainder interest was given or the fair market value at the time of the parent's death.

2. Is a formal real estate appraisal is required to establish the fair market value of the property at the relevant time?

3. General comments on personal tax situation requested

Position: 1. The ACB of remainder interest is determined under 43.1(2) with the result that, following the parent's death and absent any capital improvement's by the child, the ACB will not be more than the FMV of the property at the time the remainder interest was given.

2. No.

3. General comments on principal residence, determination of individual's residence and filing obligations as of the date of death given.

Reasons: 1. The Court addressed the taxpayer's issues concerning the effect of 43.1(2) in Depedrina et al v. the Queen (2005 DTC 1386).

2. Where there is a reference to "fair market value' as to whether a taxpayer is expected to obtain professional valuation or appraisal advise of their real estate, the answer is no. However, because the Canadian tax system is one of self-assessment, there is an obligation for taxpayers to voluntary comply and report their fair share of taxes. Taxpayers are also expected to maintain and keep, for a period of time, books and records to assist in calculating their taxable income. Depending on one's tax situation, a taxpayer may have to resort to obtaining professional assistance in order to ensure that proper books and records are well prepared and this would include hiring accountants, tax preparers, valuators or appraisers where the need is evident. There is no obligation imposed by CRA but if a taxpayer does not have the technical expertise to calculate his gains or losses for a specific transaction then it would be logical that assistance be obtained. It may be in the taxpayer's best interest to have an accurate understanding of the "fair market value" of the asset at the time of acquisition, whether or not the property was purchased or transferred in a non-arm's length transaction (ITA - 69(1)) or deemed to have been disposed at the date of death (ITA 70(5)) or some other similar transactions.

Whether a valuation analysis was prepared by a taxpayer himself or a professional valuator or appraiser, the Canada Revenue Agency is not obligated to accept the reported amount and can review the report and/or calculations provided before accepting the reported value.

XXXXXXXXXX 								2007-024292
									Annemarie Humenuk
July 18,2007

Dear XXXXXXXXXX:

Re: Computation of the Capital Gain Realized on Property Originally Acquired as a Remainder Interest

This is in reply to your letter of June 25, 2007 in which you pose several questions relating to the income tax consequences relating to property acquired from your mother.

You summarized the facts relating to your situation as follows. Your mother gave you the remainder interest of her principal residence in 2001, on which she kept a life estate as evidenced by formal deed. The life estate allowed her to keep the property as her principal residence with full responsibility and control of the property until her death. Your mother continued to be responsible for paying the taxes and other property expenses until her death in 2007. Subsequent to her death, you have obtained approval for the subdivision of the property with the intention of selling the vacant lots over the next several years, or potentially only after your death, and retaining the property with the cottage on it for your personal use when you are living in Canada.

You are asking whether, for purposes of calculating the capital gain on the disposition of the property, you must use the fair market value of the property at the time your mother gave you the remainder interest in her property or the fair market value at the time of her death. You also ask if a formal real estate appraisal is required to establish the fair market value of the property at the relevant time. You would also like information concerning the expected tax liability relating to the property held by you at the time of your death. In particular, you ask if the property would qualify as your principal residence and whether it would be possible for a resident of Italy or the U.S. to act as your executor with respect to the property located in Ontario. Our Comments:

Before addressing the questions you have raised, please note that citizenship is not relevant in determining the basis on which a person is taxed under the Income Tax Act, R.S.C. 1985 (5th supp.) c. 1, as amended (the "Act"); rather, it is the residence of the person which determines which rules are applicable in determining the Canadian income tax consequences for that person. Your letter does not contain enough information to determine your country of residence at the times that are relevant in determining the Canadian income tax consequences to you. Interpretation Bulletin IT-221R3, Determination of an Individual's Residence Status, provides information to assist an individual in determining their residence for Canadian tax purposes.

Also note that the Canada Revenue Agency is not in a position to provide you with legal advice with respect to whether a non-resident of Canada (and, in particular, a non-resident of Ontario) can act as your executor in respect of the property located in Ontario. However, if the executor or administrator of the estate is not resident in Canada, the estate will be subject to Canadian income tax as a non-resident trust, subject to any provision that would deem it to be resident in Canada. Interpretation Bulletin IT-447, Residence of a Trust or Estate, provides information on determining the residence of a trust or estate for Canadian tax purposes.

With respect for the need for a formal real estate appraisal to support the amount used as the cost of the property acquired by way of gift, paragraph 69(1)(c) of the Act states that the person is considered to have acquired the property at the fair market value at the time the gift is made. Where the individual acquires property from a non-arm's length person for more than its fair market value, paragraph 69(1)(a) of the Act states that the individual is considered to have acquired the property for its fair market value and not the amount actually paid for it. While there is no requirement in the Act for a formal appraisal or valuation to support value declared by the individual in computing any subsequent capital gain on the property, an individual who acquires property in such circumstances should have a basis for the declared value such that the individual will be able to demonstrate, in the event of an audit or review, that he or she has determined the fair market value using a fair and reasonable method.

Some of the questions posed in your letter relate to a completed transaction. For assistance in determining the adjusted cost base of your property, you should submit all relevant facts and documentation to the appropriate Tax Services Office ("TSO") for their views. A list of TSOs is available on the "Contact Us" page of the CRA website, http://www.cra-arc.gc.ca/contact/tso-e.html. Although we cannot comment on your specific situation, we are prepared to provide the following general comments, which we hope will be of assistance to you.

When an individual disposes of the remainder interest in the property, while retaining the life estate, by way of an inter vivos gift to another person, subsection 43.1(1) of the Act applies with the result that the individual is deemed to have disposed of his or her life estate in the property for proceeds of disposition equal to its fair market value at that time. Subsection 43.1(1) of the Act also deems the individual to have reacquired the life estate immediately after that time at a cost equal to the proceeds of disposition. As a result, any gain accrued on the entire property is recognized at that time by the individual. However, where the property qualifies as the individual's principal residence for the entire period in which it was owned by the individual, the principal residence exemption eliminates any gain that would otherwise be subject to tax.

Pursuant to paragraph 69(1)(c) of the Act, the individual who acquires the remainder interest in the property is deemed to acquire that interest at a cost equal to the fair market value of the remainder interest at that time.

Upon the death of the individual holding the life interest in the property and the expiry of the life interest, subsection 43.1(2) of the Act states that the individual who held the life interest is deemed to have disposed of it at its adjusted cost base and this amount is then typically added to the cost amount of the remainder interest held by the surviving taxpayer. The exact amount of the addition to the adjusted cost base of the remainder interest is lesser of the adjusted cost base of the life interest, if any, and the amount, if any, by which the fair market value of the property immediately after death exceeds the adjusted cost base of the remainder interest.

The application of subsection 43.1(2) of the Act can be illustrated with the following example:

If a mother transfers the remainder interest in her principal residence to her son when the value of the property is $300,000 and the value of the life interest is $200,000, the mother would realize a capital gain on the deemed disposition of her life interest for proceeds of disposition of $200,000 and a capital gain on the disposition of the remainder interest for deemed proceeds of disposition of $100,000. The son's cost of the remainder interest at that time would be $100,000. Assuming that the fair market value of the property at the time of the mother's death is $400,000, no further gain would be realized by the mother upon her death, but the cost of the remainder interest to the son would be increased from $100,000 to $300,000. Conversely, if the entire property was only worth $250,000 immediately following the mother's death, the cost of the remainder interest to the son would be increased from $100,000 to $250,000.

In the case of Depedrina et al v. the Queen (2005 DTC 1386), the appellant's parents signed and registered a deed in 1978 in respect of the property in which the property was transferred to the appellant, his brother and their respective wives ("the Children"), with a life interest kept by the parents. The life interest expired in 1997 on the death of the appellant's mother. In 1998, the Children sold the property for $1,850,000. In calculating the Children's adjusted cost base of the property at the time the property was sold by the Children, the Minister of National Revenue took into account the appraised value of the remainder interest in 1978. The Children argued that they did not have full ownership of the property in 1978 as their parents had retained a life estate in the property. The Minister of National Revenue took the position that the Children became owners of the property in 1978 and should be taxed on any gain that arose on the property after that time. The Court found that if the deed the parents signed was effective, the Children became owners of the remainder interest in the property in 1978 and that the Children were to be taxed on the gain that accrued on the property since 1978.

As many of the arguments raised by the Children in that case were similar to the issues raised in your letter, you may wish to read the full text of the case. The case can be found at http://decision.tcc-cci.gc.ca/en/2005/2005tcc590/2005tcc590.html. In particular, the Court noted that the deed was prepared by solicitors who should have been satisfied that the parents understood what they were signing despite the Children's allegations that they did not. With respect to the Children's complaint that the result was unfair, the Court noted that where the assessments correctly reflected the law, the Court has no ability to provide relief even if the result is harsh.

With respect to the tax consequences that are likely to apply at the time of your death, subsection 70(5) of the Act provides for a deemed disposition of each capital property owned by a taxpayer at the time of death and establishes that the proceeds of disposition for such property will be the fair market value of the property immediately before death. In the case of a non-resident of Canada, subsection 70(5) of the Act applies in respect of each property owned by that non-resident immediately before death that is taxable Canadian property as defined in subsection 248(1) of the Act, subject to any tax treaty considerations. Your executor will be required to file a final income tax return for you for the year of death and that return will include the taxable capital gain or allowable capital loss on any property that is subject to subsection 70(5) of the Act. The guide, T4011, Preparing Returns for Deceased Persons, provides information concerning the requirements for filing the final return, including the computation of any deemed disposition as a result of the death and the election that is available to defer the payment of any income tax arising from such deemed dispositions. The subsequent sale of the properties by the estate would be reported on a trust return, as explained in guide T4013, T3 Trust Guide. The cost of the properties to the estate would be determined under paragraph 70(5)(b) of the Act as the fair market value of the properties immediately before your death.

As stated in paragraph 8 of Interpretation Bulletin IT-120R6, Principal Residence, the amount of the capital gain that is exempt from tax because of the principal residence exemption is based on the number of years in which the property is owned by the taxpayer and the number of years in which the property qualifies as the taxpayer's principal residence. The property will not qualify as a principal residence for any year in which the taxpayer is not a resident of Canada. You mentioned that the property in question will be severed into several lots in the near future. In addition to the deemed disposition that arises on death and actual transfers of property, a disposition of property, with a resulting capital gain or loss, will also be recognized when there is a change in use of the property. Interpretation Bulletin IT-218R, Profit, Capital Gains and Losses from the Sale of Real Estate, Including Farmland and Inherited Land and Conversion of Real Estate from Capital Property to Inventory and Vice Versa, discusses the consequences of a change of use and the factors to be considered in determining if such a change in use has occurred. As stated in paragraph 24 of Interpretation Bulletin IT-218R, the filing of a plan of subdivision without the subsequent development activity will not generally result in a change of use of property held as capital property.

This opinion is provided in accordance with the comments in paragraph 22 of Information Circular 70-6R5. All of the bulletins mentioned in this letter are available on the Canada Revenue Agency's website, www.cra-arc.gc.ca.

We trust our comments have clarified the issues raised in your letter.

T. Murphy
Section Manager
for Division Director
International & Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch