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: Husband (H) and Wife (W) jointly own a house and a vacation cottage. As part of their divorce settlement H will transfer his 50% interest in the house to W, and W will transfer her 50% interest in the cottage to H. First, will these transfers be carried out on a tax-deferred basis under subsection 73(1)? Second, provided the ex-spouses jointly elect under 74.5(3)(b), will future gains or losses on the properties accrue to the recipients as opposed to the transferors? Finally, upon eventual sale of the properties, will H and W be entitled to the full principal residence exemption?
Position: 1) Yes; 2) Yes; 3) Yes with respect to the house, no regarding the cottage.
Reasons: 1) Unless H&W elect not to have subsection 73(1) apply, the provision would apply automatically, permitting a tax-deferred transfer of the properties described above. 2) Paragraph 74.5(3)(b) would apply, such that any future gains or losses on the properties will not be attributed to the transferor. 3) With respect to the house, the principal residence exemption should be available for all years pre-separation and for years post-separation subject to the property being designated by W. Regarding the cottage, the principal residence exemption would only be available for those years post-separation.
XXXXXXXXXX 2007-023452
M. Thomson
September 4, 2007
Dear XXXXXXXXXX:
Re: Transfer of properties between spouses on separation
We are writing in response to your correspondence of May 3, 2007, wherein you requested our views on a fairly detailed, but not uncommon, scenario involving two jointly held properties transferred under a legal separation agreement as a result of a marriage breakdown.
The scenario can be summarized as follows:
Husband (H) & Wife (W) are living separate and apart as a result of a breakdown in their marriage. As part of a legal separation agreement, H's 50% interest in a house presently owned jointly by H&W, is to be transferred to W, and W's 50% interest in a cottage presently owned jointly by H&W is to be transferred to H.
The home is currently the "principal residence" of H &W, within the meaning of section 54 of the Income Tax Act (the "Act") and, subsequent to the transfer of H's 50% interest in the house to W, it will become the principal residence of W. The cottage will become the principal residence of H subsequent to the transfer of W's 50% interest to H.
H&W intend not to "elect-out" of the automatic application of subsection 73(1) to the transfers of their respective interests in the house and the cottage and they intend to file an election pursuant to paragraph 74.5(3)(b).
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. Unless otherwise stated, all statutory references are to the Act.
Property transfer on separation or divorce
As noted in paragraph one of Interpretation Bulletin IT-325R2, entitled Property Transfers After Separation, Divorce and Annulment, subsection 73(1) allows capital property [such as a house and 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) 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 a situation:
- Paragraph four of the Bulletin states that where non-depreciable property 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 where subsection 73(1) applies to a transfer, capital property transferred between spouses may nevertheless be subject to the capital gain attribution rules in section 74.2.
However, paragraph 20 of Interpretation Bulletin IT-511R, entitled 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.
In the scenario you describe, the transfer by H&W of their respective interests in the house and cottage as described in the facts above, should be eligible for a tax-deferred rollover under subsection 73(1), subject to H&W not "electing-out" of the automatic application of the provision. Further, any gains or losses that may be realized on a subsequent sale of either the house or cottage should not be attributed-back to the transferor as long as the ex-spouses (H&W) have jointly elected to have paragraph 74.5(3)(b) apply.
Principal Residence Exemption
Where subsection 73(1) applies, subsection 40(4) will apply at the time of disposition of the house and cottage. Upon the subsequent sale of the house, W will, pursuant to paragraph 40(4)(a), be deemed to have owned H's 50% interest in the house for the length of time that it was owned by H. Under subparagraph 40(4)(b)(ii), W's (newly acquired) 50% interest in the house will be deemed to have been W's principal residence for any taxation year for which it was H's principal residence. W, in her own right, may be able to designate the house as her principal residence for the period of time in question. If she meets the "inhabited" criteria set out in section 54 and is deemed by subparagraph 40(4)(a) to have owned H's 50% interest in the house throughout the time H owned it, then, subject to the other requirements of paragraph 54(g) having been met, she would be allowed to designate the house as her principal residence for the years in question.
Based on the above, it would appear that in the scenario described the principal residence exemption would be available for the house for all the years that it was jointly owned by H&W. The exemption should also be available for years subsequent to the separation when the house is wholly owned by W, provided that the house is so designated, and that the "inhabited" criteria in section 54 are satisfied.
With respect to the cottage, assuming that both properties were purchased subsequent to 1981, as explained in paragraph 6 of IT-120R6, after 1981 only one property can be designated as a principal residence by a taxpayer for a particular year and no other property can be so designated for the year by the taxpayer or a member of the taxpayer's family unit. For the purpose of the designation, a taxpayer's family unit would generally include the taxpayer, the taxpayer's spouse or common-law partner, and the taxpayer's children (unmarried and not living in a common-law partnership) less than 18 years of age. In the above scenario, the house, not the cottage has been designated by H&W as their principal residence prior to the separation. Accordingly, the principal residence exemption on the cottage will likely be available only for those years subsequent to the separation of H&W and only where H designates the property as his principal residence and satisfies the inhabited criteria found in section 54.
We trust that the foregoing will be useful.
Yours truly,
R.A. Albert, CA
For Director
Financial Sector and Exempt Entities Division
Income Tax Rulings Directorate
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