8 April 2011 Internal T.I. 2010-0359311I7 - Distribution 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.

Principal Issues:
1) Do subsections 40(3.3) and 40(3.4) apply to deny the capital loss incurred by the Estate which would arise from the application of paragraph 107(2.1)(a)?
2) Whether the Property was distributed by the Estate to the Trusts on XXXXXXXXXX ?

Position:
1) No
2) No

Reasons:
1) The 3 children are not affiliated persons within the meaning of section 251.1. Also the 3 Trusts are not affiliated with the Estate as they are not respectively a majority interest beneficiary of the Estate.
2) No legal document has been provided that would have the effect to transfer the legal title of the Property to the beneficiaries. No document was registered under article 20 of the Land Title Act. Therefore the Trusts did not hold full title to the Property. Accordingly there was no distribution of the Property by the Estate on XXXXXXXXXX .

							April 8, 2011

	Victoria Tax Services Office		HEADQUARTERS
	Estates and Trusts			Income Tax Rulings
							  Directorate
	Attention : Darlene Hildebrand 	Danielle Bouffard
							(613) 590-2155

							2010-035931

Distribution of property by an estate

This is in reply to your email of March 4, 2010, regarding the above noted subject. We acknowledge the information provided in our telephone conversations (Hildebrand/Bouffard) and in your emails or Fax sent to us on March 12, June 9 and 15, and November 22, 2010, January 11, 2011 and February 28, 2011.

All statutory references in this letter are references to the provisions of the Income Tax Act, R.S.C. 1985 (5th supp.) c. 1, as amended (the "Act"), and the following terms have the meanings specified:

"Child" means Child 1, Child 2 or Child 3;
"Child 1" means XXXXXXXXXX , a child of the Deceased;
"Child 2" means XXXXXXXXXX , a child of the Deceased;
"Child 3" means XXXXXXXXXX , a child of the Deceased;
"Children" means Child 1, Child 2 and Child 3, collectively;
"Deceased" or "Taxpayer" means XXXXXXXXXX ;
"Executors/ Trustees" means the executors and trustees of the Estate, being Child 1 and XXXXXXXXXX ;
"Estate" means the estate of XXXXXXXXXX ;
"FMV" means fair market value;
"Property" means the principal residence of the Deceased which included, inter alia, XXXXXXXXXX ;
"Representative" means XXXXXXXXXX from XXXXXXXXXX ;
"Trust" means Trust1, Trust2 and Trust3, individually;
"Trust1" means the trust created out of the Estate for Child 1;
"Trust2" means the trust created out of the Estate for Child 2;
"Trust3" means the trust created out of the Estate for Child 3;
"Trusts" means Trust1, Trust2 and Trust3 collectively; and
"Will" means the last will and testament of the Taxpayer dated XXXXXXXXXX .

Facts & Submission

The Taxpayer died on XXXXXXXXXX . Her Will deals with the residue of the Estate, establishing 3 testamentary trusts for her Children, their spouse and issue (Trust1, Trust2 and Trust3). The residue of the Estate consists of the Property (endnote 1) and other assets. The residue of the Estate is to be divided equally between the Trusts for each of the Children.

On the Taxpayer's death, the FMV of the Property was $XXXXXXXXXX , as established by an independent expert evaluation. (endnote 2) Any gain on the Property realized as a result of the operation of subsection 70(5) on the Taxpayer's death is excluded from income by reason of the principal residence exemption in paragraph 40(2)(b). Pursuant to paragraph 70(5)(b), the Estate is deemed to have acquired the Property at a cost equal to its FMV immediately before the death of the Taxpayer.

The Property was placed on the market in XXXXXXXXXX . The listed price was $XXXXXXXXXX . An offer was made for $XXXXXXXXXX but collapsed and the Property thus remained unsold. On XXXXXXXXXX , the Estate represented that it "distributed" a 1/3 interest in the Property to each of the 3 Trusts in satisfaction of their capital interest in the Estate and elected under subsection 107(2.001) for subsection 107(2) not to apply in respect of this distribution of capital. Child1, as one of the Executors/Trustees, signed the election in a letter dated XXXXXXXXXX . Consequently, the distribution would be subject to the rules in subsection 107(2.1) and thus, the Estate would be deemed to have received proceeds of disposition equal to the FMV of the Property at the time of disposition. As the value of the Property had declined during the Estate holding period (on XXXXXXXXXX , the FMV of the Property was $XXXXXXXXXX ), the Estate computed a capital loss of around $XXXXXXXXXX , resulting from the transfer of the property to the Trusts. As the legal representative of the Estate, Child1 elected under subsection 164(6) to transfer the capital loss of the Estate that arose from the disposition of the Property to the Trusts on XXXXXXXXXX to the Deceased's final T1 return. The Estate's first fiscal year ended on XXXXXXXXXX . The Estate has not been wound up.

The Trust's first taxation year is from XXXXXXXXXX to XXXXXXXXXX . On XXXXXXXXXX , the Estate distributed $XXXXXXXXXX in cash as a distribution of capital to each Trust. Each Child is the trustee of his or her trust.

Additional information on the Property

The land title document dated XXXXXXXXXX [Form A (Section 185(1)] was produced. It showed a transfer of a ? undivided interest in the Property to Child1 in trust, a ? undivided interest in the Property to Child2 in trust and ? undivided interest in the Property to Child3 in trust for a consideration of $XXXXXXXXXX . It is our understanding that the transfers were never registered under the Land Title Act of British Colombia.

Child3 was the caretaker of the Property from XXXXXXXXXX to XXXXXXXXXX (endnote 3) . Child3 inhabited the XXXXXXXXXX from XXXXXXXXXX to XXXXXXXXXX . As per the Representative's understanding:

• The Deceased had caretakers living on the Property for many years. Their contracts were the same as Child3 in that they showed a taxable benefit of $150 for room and board per month. The rental income was not reported on the Deceased's tax returns because the rental income was less than the applicable expenses that could have been claimed.
• Child3 took over caretaking duties after the previous caretaker left.
• Any personal use of the Property was incidental to Child3 as caretaker.
• The insurance policy for the Property required someone to be living on the unoccupied Property after the Taxpayer's death.
• When Child3 became the caretaker of the Property in XXXXXXXXXX , he owned a residence in British Colombia. At some point in time, he conveyed his half interest in the residence to his former spouse.

A residential tenancy agreement between Child3 (as tenant) and the Executors/Trustees (as landlords) was signed on XXXXXXXXXX . During the Estate's first taxation year, Child3 paid by check, to the attention of Child1, $XXXXXXXXXX rent on a monthly basis. The Estate reported $XXXXXXXXXX as rental income. No expenses or capital cost allowance were claimed by the Estate. After the distribution of the Property to the Trusts in XXXXXXXXXX , another residential tenancy agreement between Child3 (as tenant) and Trust1, Trust2 and Trust3 (as landlords) was signed in XXXXXXXXXX . As per that agreement, the rent included, inter alia, water, electricity and heat. Monthly payments of $ XXXXXXXXXX were made by Child3 to Child1 "In Trust" from XXXXXXXXXX to XXXXXXXXXX . In XXXXXXXXXX , the monthly rental income of $ XXXXXXXXXX was included in the Trusts' T3 returns. No expenses or capital cost allowance were claimed by the Trusts.

The Property was sold at arm's length on XXXXXXXXXX for $XXXXXXXXXX . Child1 and XXXXXXXXXX , as executors of the Estate, were designated as the vendors or sellers of the Property (instead of Trust1, Trust2 and Trust3) as per the following documents:

• Seller's Statement of Adjustments. One of the adjustments described on the statement related to the seller's portion of estimated XXXXXXXXXX taxes;
• Land Title Act (Form A-(section 185(1))-Freehold Transfer). On paragraph XXXXXXXXXX of that document, the vendors designated as "transferor(s)" referred to # XXXXXXXXXX which is the registration under the Land Title Act in XXXXXXXXXX of the transmission of the Property from the Deceased to the Executors.
• Section 116 statement. The Estate is identified as the vendor.

Finally, in a document entitled "Order and Direction to pay", the Executors instructed and authorized the legal firm representing them, inter alia, to pay the net proceeds from the sale of the Property to the 3 Trusts in three equal portions.

Questions

1. Do subsections 40(3.3) and 40(3.4) apply to deny the capital loss incurred by the Estate which would arise from the application of paragraph 107(2.1)(a)?
2. As the transfer of the Property was not registered under article 20 of the Land Title Act, was the Property distributed by the Estate to the Trusts on XXXXXXXXXX for the purposes of the Act?

Our comments

1) Stop-loss rules

Subsection 40(3.3) of the Act generally denies or suspends a loss if a person affiliated with a trust acquires a particular capital property at any time within 30 days before or after the trust's disposition of the property and, at the end of the period, the trust or a person affiliated with the trust owns the property. When subsections 40(3.3) and 40(3.4) apply, the transferor's loss is "suspended" until neither the transferor nor an affiliated person owns the property for 30 days.

Pursuant to subparagraph 251.1(1)(g)(i), a person (for example, Trust1) and a trust (Estate) are affiliated with each other if the person (Trust1) is a majority-interest beneficiary of the trust (Estate). A "majority interest beneficiary" of a trust is defined in subsection 251.1(3) of the Act to be:

a person whose interest as a beneficiary, if any, at that time

(a) in the income of the trust has, together with the interests as a beneficiary in the income of the trust of all persons with whom the person is affiliated, a fair market value that is greater than 50% of the fair market value of all the interests as a beneficiary in the income of the trust; or
(b) in the capital of the trust has, together with the interests as a beneficiary in the capital of the trust of all persons with whom the person is affiliated, a fair market value that is greater than 50% of the fair market value of all the interests as a beneficiary in the capital of the trust."

Child1, Child2 and Child 3 are not affiliated persons within the meaning of section 251.1. Also Trust1, Trust 2 and Trust3 are not affiliated with the Estate as neither of them is a majority interest beneficiary of the Estate. Therefore, in this particular situation, the conditions set out at subsection 40(3.3) would not be met to deem the capital loss (if any) incurred by the Estate to be nil under subsection 40(3.4).

2) Was the Property distributed by the Estate to the Trusts on XXXXXXXXXX pursuant to subsection 107(2.001) of the Act?

If subsection 164(6) applies, a capital loss from the disposition of the Property by the Estate is deemed to be a capital loss of the deceased taxpayer from the disposition of the Property by the taxpayer in the taxpayer's last taxation year and not to be a capital loss of the estate from the disposition of that property. In order for subsection 164(6) to apply, the taxpayer's legal representative has to have disposed of the capital property of the estate (the Property) and realized the loss within the first taxation year of the estate and has to have made the election in prescribed manner. As noted earlier, the Estate's first fiscal year ended on XXXXXXXXXX . Consequently, the Representative had to dispose of the Property no later than XXXXXXXXXX . As noted in the facts above, the Representative maintains that a subsection 107(2.001) distribution of the Property was made in XXXXXXXXXX such that subsection 164(6) applies. You have questioned whether the Representative has in fact disposed of the Property within the prescribed one year period, since the transfer is a real estate transfer that was not duly registered under the Land Title Act of British Columbia.

Subsection 107(2.001) applies where a trust makes a distribution of a property to a beneficiary of the trust in full or partial satisfaction of the beneficiary's capital interest in the trust. The issue here is to determine whether the Executors/Trustees have in fact distributed the Property to the Trusts in XXXXXXXXXX . We conclude that Executors/Trustees have not made such a distribution. A "distribution of a property to a beneficiary of the trust" for the purposes of subsection 107(2.001) should entail a legal transfer of the Property by the Executors/Trustees, namely Child 1 and the XXXXXXXXXX to each of Trust 1, Trust 2 and Trust 3. In our view, a formal conveyance of the Property was required for there to be a distribution to the three Trusts for the purposes of subsection 107(2.001), and for the three Trusts to be considered to have disposed of their capital interest in the Estate. Something more than a transfer of the mere equitable ownership was needed. The three Trusts had to be given an absolute interest in the Property and placed in full possession of it. This would have required a positive action by the Executors/Trustees to divest their rights in the real property that is the Property. In effect, it required an action by the Executors/Trustees that was in response to their obligations to effectively allot the Property to each of the three Trusts in accordance with their proportionate shares.

A new residential tenancy agreement was signed between Child 3 and the three Trusts. This would suggest that the three Trusts were entitled to the rental income from the Property from Child 3. However, the receipt of the rental income by the three Trusts and their receipt of their share of the proceeds from the sale of the Property in XXXXXXXXXX do not change our view that there was no distribution of the Property to the Trusts as capital beneficiaries in XXXXXXXXXX . A subsection 164(6) election for tax purposes also does not constitute a distribution, nor does the production of the Land Title Act Form.

In the particular situation under review here, we have not seen any legal instrument that had the effect to transfer the legal title of the Property from the Executors/Trustees to the beneficiaries. Also, no instrument transferring the Property to the Trusts has been registered in compliance with the Land Title Act of British Columbia. If the Trusts were the legal owners of the Property, we would also have expected that they would have been the "sellers" in XXXXXXXXXX instead of the seller being the Estate of the Taxpayer, or the Executors/Trustees would have acted as agents for the three Trusts. However, when the Property was sold at arm's length on XXXXXXXXXX for $XXXXXXXXXX , Child1 and XXXXXXXXXX , as executors of the Estate, were designated as the vendors or sellers of the Property (instead of Trust1, Trust2 and Trust3) as per documents of sale as mentioned above.

Paragraphs (1) and (2) of article 20 of the Land Title Act of British Colombia mentions:

(1) Except as against the person making it, an instrument purporting to transfer, charge, deal with or affect land or an estate or interest in land does not operate to pass an estate or interest, either at law or in equity, in the land unless the instrument is registered in compliance with this Act.
(2) An instrument referred to in subsection (1) confers on every person benefited by it and on every person claiming through or under the person benefited, whether by descent, purchase or otherwise, the right

(a) to apply to have the instrument registered, and
(b) in proceedings incidental or auxiliary to registration, to use the names of all parties to the instrument, whether or not a party has since died or become legally incapacitated.

Also article 22 of the Land Title Act states:

An instrument purporting to transfer, charge, deal with or affect land or an estate or interest in land passes the estate or interest, either at law or in equity, created or covered by the instrument at the time of its registration, irrespective of the date of its execution.

As the transfer of the Property in XXXXXXXXXX was never registered, it was not enforceable against third parties. It is our understanding that the Trusts could not, for instance, mortgage or sell the Property.

In conclusion, the Property was never transferred to the Trusts in XXXXXXXXXX and therefore, the Estate was still the owner of the Property at the time of sale in XXXXXXXXXX . This represented your preliminary views, we agree with them XXXXXXXXXX .

In light of the foregoing, we believe that there was no distribution of the Property by the Estate to the Trusts in XXXXXXXXXX , there was no disposition by the Trusts of their capital interest in the Estate and, accordingly, the capital loss realized by the Estate on the disposition of the Property cannot be considered to be the loss of the Deceased taxpayer pursuant to subsection 164(6) of the Act.

These represent our views, opinions and interpretations at this time based on our understanding of the facts presented. These opinions may change if additional information is uncovered. They may also need to be reconsidered in light of the taxpayer's representations should you proceed with a reassessment based on the foregoing. We would be pleased to review these opinions at your request at a later time or to provide any other assistance.

We trust that our comments will be of assistance. Please contact Danielle Bouffard at
(613) 590-2155 if you have any additional questions.

Yours truly

Alain Godin
Section Manager
For Division Director
International and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

ENDNOTES

1 You mentioned that the Property (land and buildings) was accepted as being the Taxpayer's principal residence as this expression is defined in section 54.
2 The Victoria Appraisal Department has accepted the whole property as the taxpayer's residence and that the FMV was XXXXXXXXXX at the date of death.
3 Child3's T4 slips issued through payroll account shown the following salary: XXXXXXXXXX . He was paid $XXXXXXXXXX (which included a taxable benefit of $150 for room and board) on a monthly basis.