20 November 2001 External T.I. 2001-0085365 - Transfer of Property by an Estate

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CCRA.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.

Principal Issues: Non-resident executors of an estate comprising real property situated in Quebec and subject to life rights (usufruct or rights of use) held by the deceased's common-law spouse. Tax consequences resulting from the sale of the real property or its transfer to the deceased's common-law spouse.

Position: General comments.

Reasons: Insufficient facts.

XXXXXXXXXX 														2001-008536
																	Éric Allard-Pouliot
November 20, 2001

Dear XXXXXXXXXX:

Re: Technical Interpretation Request : Executors of an Estate in XXXXXXXXXX

This is in reply to your facsimile of February 26, 2001, concerning the tax consequences relating to the disposition by an estate of a real property situated in XXXXXXXXXX that is subject to life rights held by the deceased's girlfriend.

In your letter, you mention that yourself and your husband are the executors of the estate (the "Estate") of your husband's father (the "Deceased"). It can be implied from the facts submitted in your letter that yourself and your husband are residents of the United States, whereas the Deceased was resident in Canada. One of the Estate's assets is a house located in XXXXXXXXXX in respect of which the Deceased's girlfriend¹ (the "Spouse") was given life rights² (the "Life Rights"). The Spouse is currently living in this house but has expressed a desire to move out. It also stems from your letter that the Spouse has some rights as to the income of the Estate (you mention that she gets interest payments twice a year).

In light of these facts, you require our opinion as to what would be the tax consequences should you sell the house to a third party or, alternatively, transfer it to the Spouse in exchange for terminating all her rights as to the house and the Estate.

The particular circumstances in your letter on which you have asked for our views refer to a factual situation involving a specific taxpayer. As explained in Information Circular 70-6R4, it is not the Directorate's practice to comment on proposed transactions involving specific taxpayers other than in the form of an advance income tax ruling. However, we are prepared to offer the following general comments which may be of assistance to you.

Pursuant to subsection 70(5) of the Income Tax Act (the "Act"), a deceased taxpayer is deemed to have disposed, immediately before his death, of each capital property owned by him for proceeds of disposition equal to the fair market value (the "FMV") of the property immediately before his death. Accordingly, the deceased is taxed on any capital gain that arose prior to the date of his death. However, where the property qualifies as a principal residence for the full period of ownership by the deceased he will be exempt from capital gains tax on that property. In this regard, you will find enclosed herewith a copy of Interpretation Bulletin IT-120R5, which provides the requirements that must be met in order for a house to qualify as a principal residence. Any gain or loss arising as a result of the application of subsection 70(5) of the Act must be reported in the deceased taxpayer's final income tax return which must be filed for the period beginning on January 1 of the year of his death and ending on the day of his death.

However, subsection 70(5) of the Act does not apply in respect of any property of the deceased taxpayer that is, as a consequence of the death, transferred or distributed to the taxpayer's spouse or common-law partner who was resident in Canada immediately before the taxpayer's death, or to a trust created by the taxpayer's will, that was resident in Canada immediately after the time the property vested indefeasibly in the trust and under which the taxpayer's spouse or common-law partner is entitled to receive all of the income of the trust that arises before the spouse's or common-law partner's death and no person except the spouse or common-law partner may, before the spouse's or common-law partner's death, receive or otherwise obtain the use of any of the income or capital of the trust. Pursuant to subsection 70(6) of the Act, such transfers or distributions are deemed to be made for proceeds of disposition equal to the property's adjusted cost base (the "ACB") to the taxpayer immediately before his death. Accordingly, any capital gain that accrued prior to the date of death will be taxed in the hands of the transferee when he or she subsequently disposes of the property.

In accordance with these rules, the Deceased would therefore be deemed to have disposed of his capital properties immediately before his death. Assuming that the Life Rights constitute either a usufruct or rights of use under the CCQ, the rules found under subsection 248(3) of the Act would apply to the Life Rights. Pursuant to this provision, the Life Rights would be deemed to be a trust created by will (the "Deemed Trust") and the house would be deemed to have been transferred to the Deemed Trust and to be held in trust and not otherwise. As a result of the application of subsections 248(3) and 70(6) of the Act, the house would therefore be deemed to have been transferred by the Deceased to the Deemed Trust for proceeds of disposition equal to the ACB of the house to the Deceased. Therefore, the transfer of the house to the Deemed Trust would not result in any adverse tax consequences for the Deceased. The Spouse and the Estate would be considered as holding an income interest (the Life Rights) and a capital interest (the bare owner's rights), respectively, in the Deemed Trust. The cost of these interests in the Deemed Trust for the Estate and the Spouse would generally be considered as being nil as a result of the application of subsections 106(1.1) and 107(1.1) of the Act.

You mention in your request that the Estate is considering either selling the house or transferring it to the Spouse in exchange for terminating her Life Rights and her rights as to the Estate. Each of these options will be considered separately.

Sale to a third party

Prior to the sale of the house to a third party the Spouse would have to dispose of her Life Rights in favour of the Estate. Such a transfer would amount to a disposition of the Spouse's income interest in the Deemed Trust and, pursuant to paragraph 106(2)(a) of the Act, the proceeds of disposition received by the Spouse in consideration for the disposition of her income interest in the Deemed Trust would have to be included in her income. In this regard, paragraph 69(1)(b) of the Act provides that where a taxpayer has disposed of anything to a person with whom he does not deal at arm's length for no proceeds or for proceeds less than the FMV thereof at the time the taxpayer so disposed of it, the taxpayer shall be deemed to have received proceeds of disposition thereof equal to the FMV. Pursuant to paragraph 251(1)(b) of the Act, a taxpayer and a personal trust (the Estate would qualify as a personal trust within the meaning of subsection 248(1) of the Act) are deemed not to deal with each other at arm's length if the taxpayer is beneficially interested in the trust. As for the cost of the income interest in the Deemed Trust acquired by the Estate, it would be equal to the consideration paid to the Spouse by the Estate for such interest.

As a result of this transfer, the Estate would become the absolute owner of the house, thereby resulting in the termination of the Deemed Trust. The house would be considered as having been distributed to the Estate by the Deemed Trust in satisfaction of the Estate's income and capital interests in the Deemed Trust. The rules found in paragraph 106(2)(c) and subsections 106(3) and 107(2.1) of the Act would apply to such a distribution. As a result, the Deemed Trust would be deemed to have disposed of the house for proceeds equal to its FMV at that time and the Estate would be deemed to have acquired it for the same amount. Therefore, the distribution of the house to the Estate might give rise to a capital gain in the hands of the Deemed Trust in the event that the FMV of the house at the time of its transfer to the Estate exceeds its ACB to the Deemed Trust which, as previously mentioned, would be equal to the ACB of the house to the Deceased immediately before his death. However, depending on the circumstances, the principal residence exemption may be available to the Deemed Trust in respect of the property (see paragraph 35 of Interpretation Bulletin IT-120R5 for further details).

As for the Estate, it would be considered as having disposed of its income and capital interests in the Deemed Trust. Subsection 106(3) of the Act would apply to the disposition of its income interest in the Deemed Trust and therefore no amount would have to be included in its income with respect to such disposition. Pursuant to paragraph 107(2.1)(c) of the Act, the Estate would be deemed to have disposed of its capital interest in the Deemed Trust for proceeds of disposition equal to the cost amount to the Deemed Trust of the house immediately before that time. However, the combined application of paragraphs 107(1)(a) and (2.1)(c) and subsection 108(1) of the Act would result in the proceeds of disposition of the capital interest being equal to its ACB, thereby avoiding any adverse tax consequences for the Estate.

The subsequent sale of the house to a third party would result in a capital gain or loss to the Estate equal to the difference between the proceeds of disposition for the house and the ACB of the house to the Estate which, as a result of paragraph 107(2.1)(b) of the Act, would be deemed to be equal to the FMV of the house at the time it was transferred to the Estate by the Deemed Trust. Therefore, assuming that the FMV of the house did not increase nor decrease between the time it was transferred to the Estate and the time it was sold to a third party, this disposition would not result in any capital gain or loss for the Estate.

Regarding the income interest held by the Spouse in the Estate (i.e. her right to the interest payments), a payment, as described in subsection 106(3) of the Act, to the Spouse from the Estate in satisfaction of the Spouse's income interest in the Estate would not be a disposition producing income under paragraph 106(2)(a) of the Act and no amount would have to be included in the income of the Spouse by reason of that payment.

Transfer to the Spouse

The other option you are considering is to transfer the house to the Spouse in exchange for terminating her Life Rights and her rights as to the Estate. In this scenario, the Estate would dispose of its capital interest in the Deemed Trust in favour of the Spouse. Such a disposition could give rise to a capital gain which, as stated in paragraph 107(1)(a) of the Act, would be equal to the difference between the proceeds of disposition and the higher of the ACB and the cost amount of the capital interest. Pursuant to subsection 108(1) of the Act, the cost amount of a capital interest in a trust is generally equal to the cost amount of each property of the trust. Regarding the proceeds of disposition, as previously mentioned, paragraph 69(1)(b) of the Act provides that where a taxpayer has disposed of anything to a person with whom he does not deal at arm's length for no proceeds or for proceeds less than the FMV thereof at the time the taxpayer so disposed of it, the taxpayer shall be deemed to have received proceeds of disposition thereof equal to the FMV.

As a result of this transfer, the Spouse would become the absolute owner of the house, thereby resulting in the termination of the Deemed Trust. Just like in the first scenario, the house would be considered as having been distributed to the Spouse by the Deemed Trust in satisfaction of the Spouse's income and capital interests in the Deemed Trust. Subsection 107(2) of the Act would apply to such a distribution. As a result, the Deemed Trust would be deemed to have disposed of the house for proceeds equal to its cost amount immediately before that time and the Spouse would generally be deemed to have acquired it for the same amount. Therefore, the distribution of the house to the Spouse would generally not give rise to a capital gain in the hands of the Deemed Trust.

As for the Spouse, she would be considered to have disposed of her income and capital interests in the Deemed Trust. Subsection 106(3) of the Act would apply to the disposition of her income interest in the Deemed Trust and therefore no amount would have to be included in her income with respect to such disposition. Pursuant to paragraph 107(2)(c) of the Act, the Spouse would be deemed to have disposed of her capital interest in the Deemed Trust for proceeds of disposition equal to the cost amount to the Deemed Trust of the house immediately before that time. However, as previously mentioned, the combined application of paragraphs 107(1)(a) and (2)(c) and subsection 108(1) of the Act would generally result in the proceeds of disposition of the capital interest being equal to its ACB, thereby avoiding any adverse tax consequences for the Spouse on the disposition of her capital interest in the Deemed Trust.

Regarding the income interest held by the Spouse in the Estate, the tax consequences resulting from its disposition would be the same as in the first scenario, i.e. no amount would have to be included in the income of the Spouse by reason of that payment.

General comments

Notwithstanding which scenario you decide to implement, you must keep in mind that if the Estate or the Deemed Trust is determined by the District Taxation Office to be a non-resident of Canada at the time it disposes of the house (in accordance with Interpretation Bulletin IT-447, an estate is generally considered to reside where the executors reside; as for the Deemed Trust, it would generally be considered to reside where the beneficiary who holds the rights to use or the usufruct resides), section 116 of the Act would apply to such disposition. Under section 116 of the Act, non-resident vendors who dispose of certain types of property, including real property situated in Canada, have to notify the Canada Customs and Revenue Agency (the "CCRA") about the disposition either before they dispose of the property or after they dispose of it. In addition, before a certificate of compliance can be issued to the vendor in respect of the disposition, we have to receive either an amount to cover the tax owing, or appropriate security for any gain the vendor may realize at the time the property is disposed of. We will credit any payment the vendor provides to the vendor's account, and make the final settlement of tax when we assess the vendor's income tax return for the year. If the vendor does not comply with the section 116 requirements, the purchaser of the property may be required to deduct or withhold a specified amount (currently 25%) from the proceeds of disposition to cover any tax which the vendor owes. Please refer to Information Circular 72-17R4, a copy of which is enclosed herewith, for additional information regarding section 116 of the Act and the procedure pertaining to the issuance of a certificate under this provision.

Being the executors of the Deceased, you will also need to get a clearance certificate before distributing any property of the Estate. A clearance certificate would certify that all amounts for which the Deceased is, or can reasonably be expected to become, liable under the Act at or before the time of distribution have been paid, or that the Minister of National Revenue has accepted security for payment. The certificate would apply to amounts for which you are or may become liable for payment as the executors of the Estate. If you do not get a clearance certificate before you distribute property, you are liable for unpaid amounts, whether assessed before or after the actual distribution of property. However, this liability will not exceed the value of the property you distributed. The procedure to follow in order to get a clearance certificate is explained in Information Circular 82-6R2, a copy of which is enclosed herewith.

The above comments are an expression of opinion only and are not binding on the CCRA, as explained in paragraph 22 of Information Circular 70-6R4. We trust that the foregoing will be of assistance to you.

Yours truly,

Alain Godin
Manager
International and Trusts Division
Income Tax Rulings Directorate
Policy and Legislation Branch

Attachments

ENDNOTES

¹ For the purposes of the present letter we assumed that she and the Deceased had been living together in a conjugal relationship throughout the 12-month period ending on the day of death of the Deceased and, therefore, that she could be considered as the spouse of the Deceased for Canadian income tax purposes.

² For the purposes of the present letter we assumed that these life rights constituted either a usufruct or rights of use under the Civil code of Quebec (the "CCQ").

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