Property Transfer & Taxation

In contrast to white families, Chinese families tend to maintain stronger bonds between parents and children, with a greater emphasis on financial interdependence rather than distinct individual accounts. Consequently, it is customary for property assets to be frequently exchanged among family members.

There are typically three methods for transferring property among family members:

• gifting,
• selling at a reduced price, and
• holding property jointly (Joint Names)

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These asset transfers are commonly carried out for various reasons, such as avoiding estate certification fees (probate fees) and protecting assets from potential future creditors, particularly in the case of small businesses. Gifting is also utilized to transfer high-income to low-income family members for income-splitting purposes.

1. Gifting

Firstly, it is important to note that Canada does not impose a gift tax. However, it is still possible for the Canada Revenue Agency (CRA) to levy significant taxes under the Income Attribution Rules if one is unaware of them. Let’s now discuss three scenarios where the Income Attribution Rules are applicable.

Transfer Of Assets To A Trust (Trust)

When assets or property are transferred to a trust, the person who established the trust will generally be responsible for any capital gains resulting from the sale of those assets. Additionally, any gains from those assets will be subject to retroactive taxation on the original donor. These circumstances are governed by the Income Attribution Rules.

Transfer of Assets to Minor Children

The transfer of assets to minor children is subject to the Income Attribution Rule, which means that any income generated after the gift, such as rental income, is retroactively taxed to the original donor. However, there is an exception for capital gains earned by a minor. If a child sells a house, for example, the capital gain is taxed under the child’s own name. Therefore, from a tax-saving perspective, it may be advantageous to gift assets with significant appreciation, such as houses, stocks, jewelry, paintings, and calligraphy, to a minor family member. However, this action carries substantial risks, particularly considering that minors are maturing mentally at earlier ages. It is important to carefully consider the potential consequences under family law before proceeding.

Subsequent Appreciation/Loss Of Assets Transferred To A Spouse Or Adult Child

Loss of subsequent appreciation on assets transferred to a spouse or adult child occurs when property, such as a home, is gifted to a family member. According to the tax code, this gift is treated as if it were sold at its market value. If the market value at the time of the gift is higher than the current year’s purchase price, indicating an increase in value, added value tax will be calculated based on the standard capital gain.

In the event of gifting a primary residence, the donor is exempt from paying taxes, and the recipient purchases the property at its fair market value. If the recipient already owns the property and decides to sell it in the future, any difference between the sale price and the market value at the time of the gift will be considered a capital gain for the recipient. For instance, if a father acquires his own home for $300,000 and gifts it to his adult son at the market value of $800,000, the appreciation of $500,000 will not be subject to taxation. Subsequently, if the adult son accepts the gift and sells the house after 5 years with a market value of $1,000,000, any capital gain would be calculated as $1,000,000 – $300,000 = $700,000. However, if the adult son continues to utilize the property as an investment asset, he will be liable for taxes on the capital gain of $700,000. If the adult son has been utilizing this home for personal purposes, it will remain exempt from taxation. The capital gain on the owner-occupied home does not incur any tax obligations.

In the case of a rental home, assuming it was acquired for $300,000 in the current year and is now listed for sale at $800,000 if the father gifts the property to his adult son, tax laws treat it as if it had been sold at its market value. This gift results in a capital gain of $500,000 for the father, with 50%, or $250,000, being subject to income tax in that year.

However, there is one exception – if the transfer occurs between spouses, it is deemed to have taken place at the initial cost of the home and does not generate any capital gain. Using this same house as an example as well:

This gift involves the transfer of a rental house from a husband to his wife, which is considered a transfer at cost according to tax law. Unlike a gift from a father to an adult son, there is no requirement for a “deemed sale” between spouses. The tax law treats the husband’s gift as having a cost of $300,000. As the donor, the husband does not incur any capital gain, while the wife, as the recipient, establishes a cost base of $300,000. If the wife sells the house for $800,000 in a future year, she will generate a capital gain of $500,000, which will be taxed on the husband’s income. It is important to note that any income derived from assets gifted between spouses will be subject to retroactive taxation back to the original donor (attributed to the transferor).

Is there a way to avoid retroactive tax in this situation? The answer is yes, but the process is more complex. If you wish to avoid being subject to the Income Attribution Rules or if you are divorced and your spouse does not want to pay a significant capital gain upon selling your house, what steps should you take? You will need both spouses’ signatures and must write a letter to the CRA indicating that you do not want Section 74.2 of the Income Tax Act to apply. In other words, you are electing that the spousal rollover rules do not apply. This will allow the house to be sold at its market value, and later the wife can sell the house and be solely responsible for the resulting capital gain tax.

2. Selling At A Reduced Price

We have observed instances where families sell property to their relatives at significantly reduced prices. However, it is unwise to sell the property to a family member for less than its market value, rather than gifting it. This is because it results in double taxation.

To illustrate this, let’s consider a simplified example: Suppose an investment property was originally purchased for $100,000 and now has a market value of $500,000. If the father sells the house to his adult son for $1, it is essentially equivalent to selling it at market value. The capital gain would be $400,000 ($500,000 – $100,000), and at a tax rate of 50%, $200,000 would be included in the father’s taxable income for that year.

For the adult son, Cost = $1, which means that once the house is sold in the future (for example, the house is sold when it rises to $1 million) since the cost base is only $1, capital gain = $1 million – $1 = or 999,999, half of which is incorporated into the adult son’s income for the year to pay taxes.

3. Holding Property Jointly

A common practice among families is to establish joint accounts and acquire property through joint ownership. In this arrangement, each spouse possesses an equal share of the property. If one spouse passes away, the surviving spouse becomes the sole owner of the entire property, eliminating the need for estate distribution procedures and associated fees. Additionally, any capital gains generated are transferred without taxation under spousal transfer rules. Nevertheless, it is important to note that when the surviving spouse also passes away, tax obligations will arise in due course.

In the event that Mr. Li passes away, the joint investment property owned by him and Mrs. Li will automatically be transferred to Mrs. Li without any tax implications, given its current market value of $500,000. However, if Mrs. Li were to pass away and the property’s fair market value at that time is $600,000, her post-death account, even if inherited by her children and not sold, would still be subject to capital gains tax. Specifically, $500,000 of the appreciation will be subject to this tax. It is important to note that the tax deduction must be completed before any distribution can be made as per the will.

Due to the fact that the utilization of a joint account eliminates the need for the probate process and associated fees for property transfer, the advantages of employing a joint account are evident. Consequently, could Mrs. Li contemplate the option of establishing a joint account with her adult children to collectively possess the property and thereby evade both the added value tax and probate fees? The response is that opting for a joint account with her children might still incur capital gains tax. As per Canadian tax legislation, when assets are transferred into a joint account and the joint owners do not share a spousal relationship, the assets are treated as if they were sold, potentially resulting in tax implications.

For instance, in the case of Mr. and Mrs. Li jointly owning an investment property and desiring to transfer it to their children through a joint account, with the children possessing a 50% ownership stake, it should be noted that when the parents establish a joint account, the property itself remains unchanged. However, there is a shift in ownership, with both parents and children sharing ownership rights. Consequently, 50% of the assets are treated as a sale at this point, resulting in the parents being liable to pay capital gains tax. To illustrate further, if Mrs. Li opens a joint account with her son for her investment property, it implies that half of her property has effectively been sold. This means that half of the appreciation value of her assets is realized during the transfer of ownership. Assuming the property cost $100,000 initially and its market value at the time of opening the joint account is $500,000, half of this appreciation value ($200k) would be subject to taxation.

It is generally advised against jointly titling a self-owned property with the children if Mr. and Mrs. Li are the owners. This is due to the fact that if the property is transferred to the children as a joint account with 50% ownership, they will not qualify for the capital gains tax exemption on their own self-owned home.

In the event of Mrs. Li’s unfortunate demise after the establishment of the joint account, her son will automatically inherit the property she possesses within the account, thereby bypassing the probate process and associated fees. However, during the year of Mrs. Li’s passing, half of her property will be considered as sold, resulting in her being liable to pay tax on the capital gain. Assuming a constant cost of $100,000 and a market value of $700,000 in the year of her death, the capital gain on Mrs. Li’s half of the property has risen from $50,000 to $350,000. Consequently, $150,000 of this appreciation is subject to capital gains tax.

The article above was originally posted on bcbay.com and it’s slightly modified and posted here at blog.bchomeworld.com. To search for property, go to BCHomeWorld. To qualify for a mortgage, read this article How To Qualify For A Mortgage In BC

As a trusted real estate professional, I want to emphasize the importance of seeking professional advice when it comes to any legal matters concerning your property. Real estate transactions can be complex, and legal implications may arise that require expert guidance. Therefore, I strongly recommend consulting a qualified lawyer who specializes in real estate law. Their expertise can provide you with the necessary insights and ensure that you make informed decisions that protect your interests. Please remember that this is merely a friendly suggestion to ensure your peace of mind and safeguard your investments. If you require any assistance in finding a reputable real estate attorney, I would be happy to provide recommendations.