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: Disposition of life estate & imminence of death
Position: Comments on valuing a life estate when disposition is deemed by 70(5)
Reasons: FMV of interest depends on the facts
STEP CRA ROUNDTABLE – June 2012
QUESTION 10
Where an individual has a life interest in a property and the individual dies, the life interest is to be valued without taking into account the imminence of death of the individual. Because of this, the life interest is deemed to be disposed of immediately before death for an amount which would represent fair market value based on normal life expectancy, which may be substantially higher than the true value of the life interest to the individual given the actual circumstances. After death, the life interest has no value because it is extinguished by the event of death.
It appears in these circumstances that the individual would have a deemed disposition immediately before death with proceeds equal to the fair market value of the life interest, but the estate would not acquire a property and therefore would not be able to obtain a capital loss in respect of what is now a worthless or non-existent asset.
It is noted that a special rule applies with respect to life estates in real property (section 43.1). However, there seems to be no rule which would apply in a more general situation. For example, an individual with a life interest in a trust might fall into these circumstances.
Can CRA comment firstly as to whether the analysis outlined above is correct in their view, and secondly, whether any steps or actions can be taken to mitigate this result which seems to suggest double taxation?
CRA Response
This question has arisen perhaps due to our response to a follow-up question that was presented at the 2011 CICA Roundtable. Therein we stated:
“The determination of the FMV of the life interest at the time of death of the life tenant is a question of fact. As a matter of practice, the Income Tax Rulings Directorate does not review nor provide advice with respect to the determination of FMV of a particular property at any particular point in time. Specific questions concerning the valuation of a particular life estate for tax purposes should be directed to the valuation section of the appropriate Tax Services Offices.
As previously noted in our original response to the roundtable, under subsection 70(5) of the Income Tax Act (the "Act"), a life tenant is deemed, immediately before death, to have disposed of his or her life interest in a property for proceeds equal to the FMV of the interest at that time. For the reasons set out by the Federal Court of Appeal in The Queen v Mastronardi (77 DTC 5217), the imminence of death is not taken into account in determining the deemed proceeds of disposition of a life interest. Thus, the fact that a life interest ceases to exist upon the death of the holder is irrelevant for purposes of the application of subsection 70(5) of the Act.
That said, however, one would reasonably expect the value of a life interest to decline over time but based on the above comments, we would not generally expect the facts to support a life estate valuation of nil at a time that is immediately before the death of the life tenant”.
When one refers to a life interest they are most often referring either to a life interest in real property, which as you have pointed out is dealt with in section 43.1, or a life estate, which is generally a beneficial interest under a trust. The corpus of such a trust in which a life estate is granted is usually personal property not real property. While we agree with your analysis, this should not be a major concern given that the fair market value of a life interest in the corpus of a trust will likely only be of significant value where it is transferable or where successive life interests exist. Fair market value and how it is calculated are questions of fact. The determination of the appropriate market is part of determining fair market value and is an issue of fact: (CIT Financial Ltd. v. Canada, 2004 FCA 201 at paragraph 13, Connor v. R., [1979] CTC 365 at 366 (F.C.A.), R. v. Friedberg, 92 DTC 6031 at 6034 (F.C.A.), R. v. Pustina, 2000 DTC 6001 at 6009, paragraph 39 (F.C.A.), leave to appeal denied, 266 N.R. 393 (note).). The Act does not define "fair market value" (FMV). The common definition of FMV found in the Black's Law dictionary defines FMV as "the price that a seller is willing to accept and a buyer is willing to pay on the open market and in an arm's-length transaction; the point at which supply and demand intersect". Generally, for the purposes of the Act the CRA relies on the definition of FMV provided in paragraph 3 of Information Circular 89-3 "Policy Statement on Business Equity Valuations", which is as follows:
Definition
3. (a) Fair market value is the highest price, expressed in terms of money or money's worth, obtainable in an open and unrestricted market between knowledgeable, informed and prudent parties acting at arm's length, neither party being under any compulsion to transact.
It does not require an actual market, rather it can be based on a hypothetical market. Given that an objective market does not exist for such an interest, if you presuppose a hypothetical market, it is unlikely that knowledgeable, informed and prudent buyers would pay any amount for an interest that cannot be transferred to them. However where the possibility of transfer or of successive life interests exists the determination of fair market may be significant and the estate would thereby acquire an asset with value. It should be noted that in Mastronardi, the fair market value was easily determinable due to the nature of the asset with the only issue being whether or not the imminence of death should factor in.
Lena Holloway
2012-044287
June 12, 2012
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