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: What is the correct application of 73(1) and the attribution rules for a transfer between spouses of a cottage pursuant to a legal separation agreement?

Position: See letter - General Comments Provided.

Reasons: Reading of the legislation. Consistent with CRA publications.

2004-008995
XXXXXXXXXX Allan Nelson, C.M.A
(613) 443-7253
December 9, 2004

Dear XXXXXXXXXX:

Technical Interpretation Request: Capital Gains

This is in reply to your facsimile of August 8, 2004, and our November 16 and 17, 2004, telephone conversations (Nelson/XXXXXXXXXX) where you requested our comments concerning the income tax treatment of a cottage to be transferred from your wife to yourself. You have asked for our views on the basis that the rollover provisions of subsection 73(1) of the Income Tax Act (the "Act") apply.

Background

The relevant facts can generally be summarized as follows:

? you and your wife are living separate and apart as a result of a breakdown in your marriage;

? a cottage presently owned by your wife, and purchased with her own funds, is to be transferred to you (for no consideration) as part of a legal separation agreement;

? the present fair market value of the cottage exceeds its adjusted cost base;

? the cottage is located in Ontario and both you and your wife are residents of Ontario; and

? the cottage is, and will remain, a "personal-use property" and will not be a "principal residence" of you or your wife for any year, within the meaning of these terms in section 54 of the Act. It is also our understanding that the cottage will not be rented out and there will be no income or loss from the cottage that would otherwise be subject to the attribution rules in subsection 74.1(1) of the Act.

Our Comments

Written confirmation of the tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R5, Advance Income Tax Rulings, dated May 17, 2002. Where the transactions are completed, the enquiry should be submitted along with all relevant facts and documentation to your local Tax Services Office for their views. However, we are prepared to provide you with the following general information, which may be of some assistance to you.

As noted in paragraph 1 of Interpretation Bulletin IT-325R2 Property Transfers After Separation, Divorce and Annulment, subsection 73(1) of the Act allows capital property [such as the cottage described above] to be transferred in certain instances between spouses on a tax-deferred basis. Unless the transferor elects not to have the rollover in subsection 73(1) of the Act apply, the realization of accrued gains and losses is postponed until the recipient disposes or is deemed to dispose of the property. We also refer you to the following extracts from Interpretation Bulletin IT-325R2, which could apply to your situation:

? Paragraph 4 of the Bulletin states that where personal-use property [such as the cottage described above] is transferred (and the above noted election is not made), the transferor is deemed to have received proceeds equal to the adjusted cost base of the particular property and the recipient is deemed to have acquired the property for the same amount.

? Paragraph 16 of the Bulletin asserts that even if a subsection 73(1) rollover applies to a transfer, capital property transferred between spouses may still be subject to the rules in section 74.2 of the Act concerning the attribution of capital gains to the transferor. It goes on to list situations in which the attribution rules do not apply. Paragraph 16(c), as noted below, may be relevant to your situation:

(c) The rules concerning the attribution of capital gains and losses do not apply to dispositions of property while the parties are living separate and apart by reason of a marriage breakdown, if the parties jointly elect not to have section 74.2 apply.

Paragraph 20 of Interpretation Bulletin IT-511R Interspousal and Certain Other Transfers and Loans of Property states

By virtue of paragraph 74.5(3)(b), the attribution rules for capital gains under subsection 74.2(1) do not apply to dispositions of property occurring at any time while the spouses are living separate and apart because of a breakdown of their marriage if the spouses jointly elect not to have section 74.2 apply. Section 74.2 will cease to apply for the year the joint election is filed and thereafter. The election, which may be filed for any taxation year ending after the separation, should be filed with the transferor's income tax return.

When referring to the election in paragraph 74.5(3)(b) of the Act, the Capital Gains guide (T4037) states under the subtitle Transfers of property to your spouse or common-law partner or to a trust for your spouse or common-law partner,

For transfers of property made after May 22, 1985, you can file this election with your return for any tax year ending after the time you separated. However, for the election to be valid, you have to file it no later than the year your spouse or common-law partner disposes of the property. To make this election, attach to your return a letter signed by you and your spouse or common-law partner. State that you do not want section 74.2 of the Income Tax Act to apply.

Consequently, the wording of your sample letter of election, submitted with your August 6, 2004 request, appears to meet the above requirements.

The publications referred to in this letter may be obtained from your local Tax Services Office or from our Internet web site (www.cra-arc.gc.ca).

We hope the above will be of assistance to you.

Yours truly,

Milled Azzi, CA
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Policy and Planning Branch