20 May 2011 Roundtable, 2011-0401401C6 - CICA Conference Question 20, Life Estates

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: Various issues related to life estates and the valuation of life and remainder interests in real property (particularly in relation to document 2002-0154725)

Position: General comments provided based on published positions

Reasons: CRA historic views have been expressed

QUESTION 20

CRA document 2002-0154725 discusses division of the cost of a deceased person's asset between a beneficiary receiving a life interest and one receiving a remainder interest, with the CRA noting that the two interests must have a combined value equal to the value of the property.

Regarding such situations:

(a) Are life interests valued in view of the testator's life or the beneficiary's life?

CRA Response (a) -

When a life interest or a remainder interest in capital property is acquired by an individual as a consequence of a person's death, the adjusted cost base of that individual's interest in a property is determined under subsection 70(5) or (6) of the Income Tax Act (as is applicable in the circumstances) at the time of the person's death. As indicated in paragraph 5 of IT-226R, Gift to a Charity of a Residual Interest in Real Property or an Equitable Interest in a Trust, the fair market value (the "FMV") of a life interest at a particular time will vary according to the type of gift, other interests in the property or trust and the documentation providing for the transfer. Although the comments in IT-226R are made in the context of valuing a gift made during the lifetime of the individual holding the property, the valuation principles would apply equally upon the creation of such interests as a result of the death of an individual.

It is the CRA view that the FMV of a remainder interest in a real property at a particular time is equal to the FMV of that real property minus the FMV of the life interest therein at the particular time. The calculation of the FMV of the life interest would usually be based on the following elements: FMV of the real property, a reasonable rate of interest, life expectancy of the beneficiary of the life interest at the date of transaction (which, in this case, would be at the time of the person's death), and any other factors relevant to the specific case.

(b) Does the CRA consider the life interest and the remainder interest to be separate properties or do they consider the property as a whole to be held by one of the two beneficiaries in a trust relationship reflecting the beneficial interests of each of the life and remainder beneficiaries?

CRA Response (b) -

The determination of the legal form of any particular transaction is a question of fact and as such, the CRA is unable to provide any commentary in this regard. Whether an individual's interest in real property represents a life estate, an interest in a trust or something else in law will depend solely on the facts of each particular case.

For purposes of our comments in document 2002-0154725, the facts specifically stated that the beneficiaries in that case were party to a formal life estate agreement under common law where, pursuant to an individual's will, a life interest in real property was conveyed to a spouse while the remainder interest was conveyed to a child. As such, it was our view that each of the life interest and remainder interest represented a separate property in that case for purposes of the Income Tax Act.

(c) The CRA document 2002-0154725 indicated CRA's view that the life interest is deemed disposed of immediately prior to the death of the life tenant, with no provision for a transfer of its cost to the remainder interest holder. Does the CRA agree that this would:
o Result in no tax relief to the life tenant where the property was used for personal use?
o Result in a capital loss (or terminal loss) equal to the cost of the life interest where the property was used to earn income?

CRA Response (c) -

Under subsection 70(5) of the Act, a life tenant is deemed, immediately before death, to have disposed of his or her life interest in the property for proceeds equal to the FMV of the interest at that time. Where the property that is subject to the life interest is personal use property, subparagraph 40(2)(g)(iii) of the Act will apply to deny any capital loss that may arise as a result of this deemed disposition. However, where the property is not personal use property as that term is defined in section 54 of the Act, subparagraph 40(2)(g)(iii) would have no application; however, whether any property is personal use property for purposes of the Act is a question of fact.

The determination of the FMV of the life interest at the time of death and any resulting capital loss, if otherwise not denied, is a question of fact. It is the CRA view, however, that the imminence of death is not taken into account in determining the deemed proceeds of disposition of a life interest for the reasons set out by the Federal Court of Appeal in The Queen v Mastronardi (77 DTC 5217), although one would reasonably expect that the value of a life interest to decline over time unless the annual level of income from the property increases to sufficiently compensate for the life expectancy factor.

(d) The CRA document 2002-0154725 also indicated the remainder interest would have a cost equal to the value of the property as a whole, less the value of the life interest, and that the cost of the life interest to the life tenant would have no impact on the remainder beneficiary's tax cost. Does the CRA agree that the remainder beneficiary would compute recapture and capital gains on a depreciable property originally inherited as a remainder interest on the basis that the value of the remainder interest at the date if the testator's death forms the original cost of the property, unadjusted for the value of the life interest? Does the CRA's interpretation vary depending on whether the property is disposed of during the life of the life tenant?

CRA Response (d) -

As stated in document 2002-0154725, there is no provision in the Act which allows an amount to be added to the adjusted cost base of the remainder interest in the property as a result of the expiry of the life interest upon the death of the life tenant. Any capital gain realized on the ultimate disposition of the property would be equal to the proceeds of disposition of the property less the adjusted cost base of the remainder interest to the remainder interest holder (as determined at the date of the testator's death) and any selling costs.

Whether or not this position would apply in respect of property that is depreciable property and where the disposition of the property occurs either during the life of the life tenant or after their death, would be an issue the Income Tax Ruling Directorate would be pleased to consider in the context of technical interpretation.

(e) Subsections 70(9) and (9.01) permit land in Canada or depreciable property in Canada used in a farming business to be transferred to children of the owner at a value between its ACB and its FMV. Does the CRA consider a life or remainder interest in farm property to qualify for purposes of these provisions? Would the answer differ if either the interest or remainder beneficiary were not a child of the testator?

CRA Response (e) -

In general, subsection 70(9) allows land in Canada or depreciable property in Canada of a prescribed class, that is held by a taxpayer, to be transferred on a tax-deferred basis on death to a child of the taxpayer, pursuant to subsection 70(9.01) of the Act, where the following requirements are met:

a. The property was, before the taxpayer's death, used principally in a farming business carried on in Canada in which the taxpayer, the spouse or common-law partner of the taxpayer, or a child or parent of the taxpayer, was actively engaged on a regular and continuous basis;
b. The child was resident in Canada immediately before the day the taxpayer died; and
c. As a consequence of the taxpayer's death, the property is transferred to and becomes vested indefeasibly in the child within 36 months after the taxpayer's death.

Interpretation Bulletin, IT-349R3, Intergenerational Transfers of Farm Property on Death, discusses the general application of this rollover provision. In general terms, where the above-mentioned conditions have been satisfied, the legal representative of the deceased taxpayer may elect to transfer the particular property at any amount between its cost amount and its fair market value immediately before the time of the death of the taxpayer. The elected amount is deemed to be the cost of the property to the child. Note that for purposes of these rules, a child of the taxpayer has the extended meaning as provided for in the definition of "child" in subsection 70(10) of the Act.

In paragraph 7 of Interpretation Bulletin IT-268R4, Inter Vivos Transfer of Farm Property to Child, we state that in certain circumstances, the CRA will regard a remainder interest in land as "land" for the purposes of the inter vivos rollover in subsection 73(3) of the Act. However, whether or not this position as outlined in IT-268R4 would extend to a particular interest in real property for purposes of subsections 70(9) and (9.01) has not been fully considered by the CRA given the differences between the provisions. As such, we suggest guidance be sought from the Income Tax Ruling Directorate in this regard.

Kimberly Duval
613-957-8585
May 20, 2011
2011-040140