The article “Capital gains when selling property to family” was originally published in MoneySense on March 18, 2022. Photo by cottonbro from Pexels.
If you sell a property to a relative for a bargain price, does that mean you pay less tax for capital gains?
Do I have to pay income tax if I inherited a property jointly with my sister and she bought me out for less than half the appraised value of the property? —Johanna
Capital gains and transferring property between family
Asset sales between family members can be tricky to facilitate at a family level, let alone from a tax perspective. There are tax implications to be aware of here, Johanna.
First, a primer on how capital gains tax works. For real estate, it’s based on the sale price, minus the selling costs, capital improvements made to the property, and your adjusted cost base (ACB) or acquisition cost.
Also, it’s important to know that 50% of a capital gain is taxable and is added to your other sources of income for the tax year. A large capital gain—for example, on a piece of real estate—can easily push you into a higher tax bracket.
What qualifies as a principal residence and other exemptions
There are nuances related to real estate like whether or not a property might qualify as a principal residence. The sale of a principal residence is generally tax-free. A cottage can qualify as your principal residence as long as you ordinarily inhabit it. It does not need to be the primary place that you live. However, claiming a cottage as your principal residence may expose your home to capital gains tax in the future since you will be limiting the number of years it can qualify as your principal residence.
For example, if you have owned your house for 20 years and your cottage for 10 years and claim the cottage as your principal residence, you will lose 10 years for your house. If you sell your house after 30 years of ownership, 10/30ths will generally be subject to capital gains tax.
Another consideration is whether a capital gains exemption was declared in 1994 if you inherited the property prior to that time. An exemption of up to $100,000 was available until 1994 and taxpayers were allowed to bump up their cost base on eligible capital property like cottages by up to $100,000 on their tax returns that year.
Determining fair market value
In your case, Johanna, because you inherited the joint property, your initial adjusted cost base or acquisition cost should be one-half of the fair market value as of the date of death of the person who left you the cottage. They would have been deemed to have sold the property at fair market value on their death—a so-called deemed disposition. If the property was not their principal residence, they would have paid tax on their capital gain, if applicable, at that time.
So, if you are not sure of the value at the time of your acquisition, you could generally determine this from the deceased’s final tax return or estate information return for probate purposes where this value would be listed.
A sale of property to a family member or someone who you are not dealing with at “arm’s length” generally takes place—for tax purposes—at fair market value. This is the case even if you legally sell it for less than the fair market value, as was the case with your sister. The same would apply even if you gifted it and were not paid a penny. So, using an artificially low sale price won’t negate the capital gains tax. Capital gains will be calculated based on the fair market value price, Johanna.
Capital gains and inheriting a property
If you have recently inherited the property, it may be that the current fair market value of the property and your adjusted cost base are roughly equal, meaning little or no capital gains tax payable.
However, if it’s been a year or more, there’s a good chance that the value has increased based on the performance of many Canadian real estate markets. A realtor may be needed to perform a market value analysis and give you your fair market valuation.
Selling to family
I’m not sure what the motivation was for selling the property at a discount to your sister, Johanna. If it was pure generosity, that’s nice of you, but you still may have tax to pay. Given your charitable intention, you should probably get a donation receipt! But you won’t, of course.
If the capital gain is a large one, and you don’t need the funds, you may consider splitting the receipt of funds from your sister over a period of up to five years, if it’s not too late.
When you do this, you may be able to claim a capital gains reserve and split the capital gain over up to five years and potentially pay less tax. Whether or not this is possible or even worth it is a matter of fact.
For example, the capital gain may not be that significant, or you may be able to offset it with a contribution to your registered retirement savings plan (RRSP) using the sale proceeds from your sister.
In summary, there may be capital gains tax payable on the sale of the home, despite the discounted price, Johanna. This reinforces why it’s advisable to solicit tax advice in advance of undertaking these sorts of transactions to ensure that you understand all of the facts and how best to plan accordingly.
This column was originally published on April 19, 2016. It was last updated on March 18, 2022.
Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto, Ontario. He does not sell any financial products whatsoever.