Translation disclaimer
This translation was prepared by Tax Interpretations Inc. The CRA did not issue this document in the language in which it now appears, and is not responsible for any errors in its translation that might impact a reader’s understanding of it or the position(s) taken therein. See also the general Disclaimer below.
Principal Issues: [TaxInterpretations translation] (1) What are the tax consequences of a transfer from one spouse to another of an interest in the couple's principal residence?
(2) What are the tax consequences of one spouse transferring an interest in a capital property, other than a principal residence, to another spouse? What if, at the time of the transfer, the spouses are living separate and apart due to marriage breakdown?
(3) Are the results in (1) and (2) different if the transfer arises from a separation or divorce judgment relating to the division of the spouses' property?
Position: (1) Assuming that an election under subsection 73(1) is not made, an inter vivos transfer of an interest in the couple's principal residence will be at an amount equal to the adjusted cost base of the interest and will be deemed to have been owned by the transferee during the period it was owned by the transferor. Section 74.2 will not apply to that transfer.
(2) Assuming that an election under subsection 73(1) is not made, an inter vivos transfer of an interest in capital property will be at an amount equal to the adjusted cost base of the interest. On the subsequent disposition of the capital property, section 74.2 will apply to attribute the capital gain amount on the interest to the transferor. However, under paragraph 74.5(3)(b), there is no attribution of the capital gain if the spouses, who are living separate and apart at the time of the transfer because of a breakdown of their marriage, make an election under that paragraph.
(3) The capital gains attribution rules do not apply to the portion of the capital gain attributable to the period when the transferee ceases to be the spouse of the transferor. In the context of a separation, the capital gains attribution rules will not apply if the spouses make an election under paragraph 74.5(3)(b).
Reasons: The Income Tax Act.
XXXXXXXXXX 2006-016604
April 24, 2006
Dear Sir,
Subject: Request for technical interpretation - Inter vivos transfers of fixed assets inter vivos
This is further to your faxed letter received on January 6, 2006, requesting our opinion on the tax consequences of transfers of capital properties - including a principal residence - between separated spouses.
FACTS
Your request for a technical interpretation states the following facts:
- A couple married in 1975 in Quebec under the regime of separation of property;
- In 1991, the spouses - then XXXXXXXXXX - jointly purchased an immovable ("Immovable1") located in Canada which was intended to serve as their principal residence upon their return to Canada;
- The spouses separated in 1992;
- The separation of the spouses did not constitute a judicial separation and was not effected pursuant to a written separation agreement;
- Upon their return to Canada and following their separation, the wife bought a house in 1992 ("Immovable2") which immediately became her principal residence;
- The wife remained a co-owner of Immovable1;
- The husband became a co-owner of Immovable2 in order to secure the wife's mortgage claim, even though he did not make any monetary disbursements;
- The husband never lived in Immovable2;
- Immovable1 has been the husband's principal residence since May 1995;
- Between the time of the purchase of Immovable1 and May 1995, Immovable1 was used to earn rental income;
- The wife has never lived in Immovable1;
- To this day, the two spouses remain joint owners of the two residences in equal shares;
- Each of the spouses now wishes to sell his or her undivided share of the immovables to the other spouse for $1 so that each of them becomes the sole owner of the residence they live in.
QUESTIONS
With respect to the facts you have submitted to us and in view of the intention of both spouses to transfer their respective interests in Immovable1 and Immovable2, you wish answers to the following three questions:
(1) What are the tax consequences of a transfer from one spouse to the other of an interest in a capital property that is the couple's principal residence?
(2) What are the tax consequences of a spousal transfer of an interest in capital property other than a principal residence? What if, at the time of the transfer, the spouses are living separate and apart due to marriage breakdown?
(3) Does it make a difference if the transactions in (1) and (2) arise from a separation or divorce judgment relating to the division of the spouses' property?
ANALYSIS
A. Designation of a building as a principal residence
Section 54 of the Income Tax Act (the "Act") provides the definition of "principal residence". Under this provision, a principal residence is defined as follows:
[P]roperty that is a housing unit, a leasehold interest in a housing unit or a share of the capital stock of a co-operative housing corporation acquired for the sole purpose of acquiring the right to inhabit a housing unit owned by the corporation and that is owned, whether jointly with another person or otherwise, in the year by the taxpayer, if
(a) where the taxpayer is an individual other than a personal trust, the housing unit was ordinarily inhabited in the year by the taxpayer, by the taxpayer’s spouse or common-law partner or former spouse or common-law partner or by a child of the taxpayer,
As stated in this provision, in order for a property to be designated as the principal residence of a taxpayer (in this case, yourself), it is necessary that the property be "ordinarily inhabited" by the taxpayer, the taxpayer's spouse or common-law partner or former spouse or common-law partner, or by a child of the taxpayer.
In addition, the same section states that, in order to be a taxpayer's principal residence, a property must have been designated as such. For the 1982 and subsequent taxation years, it is not possible for two spouses to designate two properties as a principal residence in the same year. In other words, if a property is designated as the principal residence of one spouse, the other spouse cannot designate another property as that individual’s principal residence for the same period. This rule applies equally to spouses who are living separate and apart (not under a judicial separation or written separation agreement). The key passages of section 54 read as follows:
[E]xcept that, subject to section 54.1, (which is not applicable in your situation), a particular property shall be considered not to be a taxpayer’s principal residence for a taxation year
(c) where the taxpayer is an individual other than a personal trust, unless the particular property was designated by the taxpayer in prescribed form and manner to be the taxpayer’s principal residence for the year and no other property has been designated for the purposes of this definition for the year
(i) where the year is before 1982, by the taxpayer, or
(ii) where the year is after 1981,
(A) by the taxpayer,
(B) by a person who was throughout the year the taxpayer’s spouse or common-law partner (other than a spouse or common-law partner who was throughout the year living apart from, and was separated under a judicial separation or written separation agreement from, the taxpayer),
Under section 2301 of the Income Tax Regulations, a taxpayer must designate a property as a principal residence for any taxation year in which the property is disposed of. In your case, the designation should be made for the 2006 taxation year. Form T2091 - which we are attaching to this letter - should be used for the designation.
However, according to the CRA's administrative practice1, a taxpayer is not required to file Form T2091 in the following circumstances:
(a) there is a taxable capital gain from the disposition of the property after the principal residence exemption formula has been used;
(b) you or your spouse filed Form T664, Election to Report a Capital Gain on Property Owned at the End of February 22, 1994, in respect of the property, and the property was the taxpayer's principal residence for the 1994 year or was designated in the year as a principal residence for any taxation year.
Of course, it is your responsibility to determine whether a principal residence designation should be filed.
In your situation and in light of the facts you have provided, Immovable1 cannot be your principal residence for the 1991 to 1994 taxation years inclusive since neither you nor your wife lived there during that period. Consequently, Immovable2 could be your principal residence for the years 1992 to 1994 inclusive since your wife lived there, provided your wife did not designate another property as her principal residence for those years.
For the years 1995 and later, we are of the view that either Immovable1 or Immovable2 could be your principal residence, since each of you and your wife "ordinarily" inhabited those housing units during those years. On the one hand, Immovable1 could be your principal residence since you "ordinarily" inhabited it during those years. Alternatively, Immovable2 could come within the definition of "principal residence" since it was "ordinarily inhabited" by your wife during those years.
As we wrote earlier, you and your wife must designate the same property as your principal residence for the years in which you were not separated by a judicial separation or written separation agreement. For the purposes of our interpretation, we have assumed that your wife will designate Immovable2 as her principal residence for the years 1995 to 2006 inclusive (as well as 1992, 1993, and 1994) and that, as a result, you must designate the same property for the years 1995 to 2006. If this is the case, Immovable1 will be treated as a capital property subject to the change-in-use rules.
B. Transfer of an interest in a principal residence
Where a capital property is transferred from an individual to the individual’s spouse or common-law partner, subsection 73(1) provides that the transfer of such property may be made without tax consequences, i.e., it may be made at an amount equal to the adjusted cost base of the property (generally the price paid for the property), unless both spouses elect to transfer the property at its fair market value determined at the time of transfer. If the property is not a principal residence, there may be attribution to the transferor of a taxable capital gain realized on the subsequent disposition of the property by the transferee.
However, where the transferred capital property is a property in respect of which the principal residence exemption applies, subsection 40(4) deems the transferred property to have been owned by the transferee for the period during which it was owned by the individual.
In this case, you became a co-owner of Immovable2 at the request of the financial institution because of your wife's financial situation. According to our information, you never lived in Immovable2 during all the years in question and you made no financial disbursements in relation to that property. Thus, the terms and conditions of the transfer of your interest in Immovable2 are intrinsically linked to the nature of your ownership in that building.
In Quebec civil law, dismemberment of right of ownership is more limited than in other Canadian provinces. Thus, once an individual holds legal title to property, the individual normally possesses all the attributes of ownership (including possession, use, risk of loss and the obligations arising from those attributes). Consequently, we have assumed for the purposes of our technical interpretation that you have an ownership interest equal to one-half of the fair market value of the Immovable2.
The transfer of your interest in Immovable2 to your wife will be at the adjusted cost base (generally one-half of the purchase price of the immovable) of the interest. Thus, under subsection 40(4), that interest will be deemed to have been owned by your wife for the entire period during which it was owned by you, i.e. from 1992 to the present. Thus, when your wife disposes of Immovable2, she will be able to benefit from the principal residence exemption for all the years during which Immovable2 was her principal residence in order to minimize or even eliminate any taxable capital gain.
The transfer of your interest in Immovable2 to your spouse will have no tax consequences for you - that is, you will not realize a taxable capital gain or allowable capital loss - provided the transfer is made at the adjusted cost base.
C. Transfer of a Capital Property - Other than a Principal Residence - to a Spouse or Common-Law Partner
(i) Change of use of property originally used to earn income
Paragraph 45(1)(a) provides that there is a disposition at fair market value where a property, acquired for the purpose of gaining or producing income, is subsequently used for another purpose (e.g., as a taxpayer's residence). That deemed disposition may therefore give rise to a taxable capital gain unless the taxpayer has elected out of the deemed disposition. Under subsection 45(3), that election must be made on or before the filing due date of the return for the year in which the property is ultimately sold. That election therefore allows the deferral of the capital gain accrued during the period the property is leased.
However, if a taxpayer claims capital cost allowance where the property is used to produce income, the subsection 45(3) election cannot be made. Thus, the change in use would result in a capital gain or loss, depending on the fair market value of the property at the time of the change in use, and could also result in either a terminal loss or recapture to be included in the taxpayer's income.
In light of the facts that are the subject of this technical interpretation, it would appear that you and your wife had a secondary intention of renting out Immovable1 for any period when it was not being used as your principal residence. Thus, the change of use appears to have occurred in May 1995 when you stopped renting the Immovable1 in order to use it as your place of residence. Unless you made an election under subsection 45(3), a deemed disposition would have occurred on that date. However, following a telephone conversation on March 24, 2006, in which you confirmed that you never claimed capital cost allowance for Immovable1 during the years it was used to produce income, we are of the view that the election provided for in subsection 45(3) can be made to defer the capital gain otherwise realized following the change in use of this property.
(ii) Inter vivos transfers of capital property
As noted above, capital property - and thus your wife's ownership interest in Immovable1 - can be transferred without tax consequences between spouses or common-law partners. If a deemed disposition under paragraph 45(1)(a) occurs, then the transfer of the property under subsection 73(1) will be at an amount equal to the amount of the deemed disposition. For example, if a property is subject to a deemed disposition under paragraph 45(1)(a) and the proceeds of disposition are $200,000, then the transfer under subsection 73(1) will be for $200,000. Of course, the spouses may choose not to take advantage of subsection 73(1) and transfer the property at its fair market value, which may have immediate tax consequences.
Another tax consequence may arise from the transfer of a capital property between spouses or common-law partners (or between persons who subsequently become spouses or common-law partners). In such a case, the capital gain realized by the transferee on the subsequent sale of the property may have to be included in the transferor's income. Note, however, that subsection 74.5(3) excludes the application of this attribution rule if the transfer occurs between spouses who are living separate and apart at the time of the transfer – by reason of a breakdown of the marriage or common-law partnership - and if the spouses jointly elect in the individual's return of income for the year of the transfer.
Thus, the transfer by your wife of her interest in Immovable1 will not give rise to any tax consequences to her since the transfer will normally be for an amount equal to its acquisition cost (provided that the election under subsection 73(1) is not made). Provided that the election under subsection 74.5(3) is made jointly by you and your wife, there will be no attribution of the capital gain realized on a subsequent sale of Immovable1.
D. Do our conclusions remain the same if the above-described transactions between the spouses are the result of a separation or divorce judgment dealing with the division of the spouses' property?
The provisions of section 73 dealing with the transfer of capital property apply equally to transfers between spouses or common-law partners and to transfers between former spouses or common-law partners in settlement of rights arising out of their marriage or common-law partnership. Accordingly, our conclusions on the application of section 73 to the facts of this case do not change if the transactions arise from a separation or divorce judgment relating to the division of spousal property.
Under the Act and Interpretation Bulletin IT-511R, the capital gains attribution rules in section 74.2 of the Act do not apply to the period after the transferee of the capital property ceases to be the transferor's spouse. In other words, if any portion of the capital gain from the disposition of the capital property by the transferee is attributable to the period when the transferee is no longer the spouse of the transferor, that portion of the capital gain will not be attributed to the transferor.
As stated above, if a transfer of capital property is made while the spouses are separated by reason of a breakdown of their marriage - whether or not there is a separation judgment - the capital gain attribution rules will not apply if the spouses make an election under paragraph 74.5(3)(b). Such an election must be made on the transferor's income tax return for the year of the transfer or an earlier year.
In practical terms, that means that the capital gains attribution rules may not apply to your situation. On the one hand, if you and your spouse make the election under paragraph 74.5(3)(b) while living separate and apart, no capital gain will be attributed to the transferor. If the marriage is subsequently terminated by a divorce decree, the attribution rules will not apply to the capital gain attributable to the post-marital period.
We hope that these comments are of assistance. Should you require further information regarding this letter, please do not hesitate to contact us.
François D. Bordeleau, LL.B.
Individuals, Business and Partnerships Section
Business and Partnerships Division
Income Tax Rulings Directorate
Encl.
ENDNOTES
1 See Interpretation Bulletin IT-120R6.
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