Introductions

When people are passing on capital property to their family members, they do so for various reasons including trying benefit from a lower tax bill. Some will sell the property to their family for a dollar and claim there was a capital loss. However, just because someone does it, doesn’t mean the CRA won’t review it and come back at the family with a tax bill. CRA has specific rules on these types of transfers which the article below will discuss in further detail.

The basics - Capital gain

There is a capital gain when someone sells a capital property for more than the adjusted cost base (ACB) and the expenses incurred to sell the property. The ACB of property generally includes the cost of a property plus any expenses to acquire it, such as realtor commission and legal fees. With some exceptions, Canadians are taxed on 50% of total capital gains.

General rules

The Income Tax Act (ITA) has special rules to prevent the elimination or reduction of tax by selling a capital property to a related (non-arm’s length) person at a price other than fair market value (FMV) or as a gift. Taxpayers are considered not to be dealing at arm’s length if they are related. A person is related to another by blood, marriage or common-law partnership, or adoption. Except for a transfer between spouses, capital property transfers should be carried out either at the property’s FMV or as a gift. Doing otherwise may attract adverse tax consequences on the difference between the FMV of the property and the actual transfer price, as illustrated below.

Transfer between spouses

Most transfers between spouses under the ITA do not trigger immediate tax liabilities. By default, the transferor spouse is deemed to have sold the property at the transferor’s ACB. The transferee spouse is deemed to have acquired the property at the transferor’s ACB. As a result, the transferor does not have a capital gain since the deemed proceeds are equal to the ACB. The appreciated value in the property at the time of the spousal transfer is taxed when the property is sold to a third party. The rules can be illustrated with the following example.

The husband bought a house in 2012 for $1 million. In 2020, the husband transferred the house to his wife when the house was worth $2.5 million. The husband is deemed to have transferred the house to his wife for $1 million. The husband’s capital gain on the transfer is Nil ($1M deemed proceeds – $1M ACB). The wife is deemed to have acquired the house from her husband for $1 million. Assuming the wife sold the house to a non-related person in 2022 for $2.8 million, the wife would realize a capital gain of $1.8 million ($2.8M actual price - $1M deemed ACB). This capital gain would then be attributed back to the husband and taxed on the husband’s return.  The total capital gain realized by the husband is $1.8 million (NIL in 2012 + $1.8M in 2022).

Although the ITA treats transfers between spouses favourably, the couple, in certain circumstances, may want to make an election to treat such transfers as carried out at the FMV of the property.

Transfers between other non-arm’s length parties

As previously stated, the ITA is punitive when the non-arm’s length parties transfer capital properties at a price other than the FMV of the property or as a gift. Different rules apply based on the FMV of the capital property in relation to the actual transfer price.

Actual price = FMV or as a Gift

When the capital property is transferred at its FMV or as a gift, the seller is deemed to have disposed of it at its FMV. The purchaser is deemed to have acquired the property at its FMV. There is no double taxation.

For example, John bought a rental property in 2012 for $1 million. He sold the property to his son for $2.5 million or gifted the property in 2020 when the FMV of the property was also $2.5 million. John has a capital gain of $1.5 million ($2.5M actual/deemed proceeds - $1M actual ACB). The son is deemed to have acquired the property for $2.5 million. Assuming the son sold the property to a non-related party in 2022 for $2.8 million, he will have a capital gain of $0.3 million ($2.8M actual proceeds – $2.5M deemed ACB). John and his son realized a total capital gain of $1.8 million ($1.5M in 2020 + $0.3M in 2022). I will now compare the capital gain in this scenario with other scenarios below where the actual price is less than or greater than the FMV of the property.

Actual Price < FMV

Where the actual transfer price is less than the FMV of the property at the time of the transfer, the seller is deemed to have disposed of the property at its FMV. On the other hand, the purchaser is deemed to have acquired the property at the actual transfer price. Consider the following example.

John bought a rental property for $1 million in 2012. When the property was worth $2.5 million in 2020, John sold it to the son for $1 only. John is deemed to have sold the property for $2.5 million and realized a capital gain of $1.5 million ($2.5M deemed proceeds – $1M actual ACB). The son is deemed to have bought the rental property for $1. If the son sold the house in 2022 for $2.8 million to a third party, he would realize a capital gain of $2,799,999 ($2.8M actual proceeds - $1 actual ACB). The total capital gain realized by John and his son is $4.29 million ($1.5M in 2020 + $2.79M in 2022). Since the transfer is not carried out at the FMV of the property or as a gift, John must pay tax on the capital gain as if the property was sold at its FMV. The son must not only pay tax on the capital gain realized after the property was transferred to him but also a tax, punitive in nature, on the difference between the FMV of the property and the actual transfer price when he got the property from John.

Actual Price > FMV

If the actual transfer price exceeds the FMV of the property, the seller is deemed to have disposed of the property for the actual transfer price. The purchaser is deemed to have acquired the property at the FMV of the property. Consider the following example.

John bought a rental property for $1 million in 2012 and sold the property to his son in 2020 for $3 million when the FMV of the property is $2.5 million. John is deemed to have sold the property for $3 million and realized a capital gain of $2 million ($3M actual price - $1M actual ACB). The deemed ACB of the property to the son is $2.5 million. Assuming the son sold the property in 2022 for $2.8 million, he would have a capital gain of $0.3 million ($2.8M actual price - $2.5M deemed ACB). John and the son realized a total capital gain of $2.3 million ($2M in 2020 + $0.3M in 2022). If John would have transferred the property at FMV or gifts the property, he would have saved the tax on the $0.5 million capital gain, which represents the difference between the actual transfer price and the FMV of the property. As long as the actual transfer price is equal to or greater than the FMV of the property, the son’s ACB is always $2.5 million (the FMV at the time of the transfer).

Summary

In summary, when a person transfers capital property to a related party, it is crucial to carry out the transfer at the FMV of the property or as a gift to avoid adverse tax consequences. The table below summarizes the tax implications of each scenario.

Scenarios Deemed proceeds to the seller Deemed ACB to the buyer

Actual Price = FMV FMV FMV

Actual Price = NIL (gift) FMV FMV

Actual Price < FMV FMV Actual Price

Actual Price > FMV Actual Price FMV

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This article provides general information on the topic for educational purposes only and may not be current. It is not intended as legal advice and should not be relied upon. Please consult a tax lawyer as each person’s situation is different.

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