The article “Do you pay capital gains tax when separating or divorcing?” was originally published in MoneySense on January 24, 2022. Photo by Ketut Subiyanto from Pexels.
Concerned about the potential capital gains tax implications of a principal residence after a relationship breakdown?
I just read your article on paying capital gains on a property inherited from a spouse when there was no official separation agreement in place. Interesting, and I have a related question. If spouses separate with an official separation agreement but keep the matrimonial home and mortgage in both names, as one spouse living in the house and assuming all payments, does the spouse that leaves have to pay capital gains at that time or later when the home is finally sold? If ever? – Mark
Capital gains tax when separating or divorcing
When spouses separate or divorce, there is often an equalization of net family property and a transfer of assets between them. Spousal or child support payments may also be required to be paid from one spouse to the other thereafter.
Money in a registered retirement savings plan (RRSP), or similar retirement account, can be transferred from one spouse to another without triggering any tax implications such that the funds remain tax deferred.
Likewise with capital assets—like non-registered investments, rental properties, or private company shares—that may be subject to capital gains tax. These assets can be transferred at the adjusted cost base without triggering tax if the transfer comes as a result of the settlement. Unlike transfers between spouses where attribution may cause the future income or capital gains to be taxed back to the transferring spouse, transfers to a former spouse may be exempt from the attribution rules. The attribution rules do not apply after divorce. They also do not apply if the parties are living separate and apart due to a marriage breakdown and the parties make a joint election.
When spouses separate or divorce, it is important to consider the deferred tax liabilities that one spouse or the other may be left with after an equalization. In other words, if one spouse gets tax-free assets like a principal residence or a tax-free savings account (TFSA), and the other gets tax deferred assets like RRSPs or a rental property, the spouse with the tax-deferred assets may be receiving less after considering taxes.
The rules around principal residence
Your situation with both spouses continuing to own the matrimonial home and be joint on the mortgage, Mark, brings up a few considerations. In order for a property to qualify as a tax-free principal residence, it must be ordinarily inhabited by the taxpayer, their spouse or common law partner, their former spouse or common law partner or their child. So, a home where your former spouse lives can qualify as your principal residence.
However, only one home can qualify as your principal residence for a particular year. So, if you own and live in another home while your ex stays in your matrimonial home, only one can be considered your principal residence each year.
The home-related costs to consider when uncoupling
In my opinion, Mark, the tax considerations are less important than the legal, credit or practical implications in this case. If your former spouse lives in your home and you are still on title and on the mortgage, what happens if:
- There are repairs or renovations to be done? Who pays?
- You want to get your equity out of the home? What is the process?
- The home value rises? Do you both share equally in the appreciation?
- Your ex wants to buy you out. When and how do you value the home?
- Your ex wants to borrow on a home equity line of credit secured by the home’s value?
- Your ex renegotiates the mortgage and there’s a mortgage penalty?
- Your ex’s new partner moves into the house?
- Your ex stops paying the mortgage payments, property tax, insurance, or other costs?
- You want to apply for a new mortgage but cannot qualify because of the existing debt?
- You or your ex becomes disabled?
- You or your ex dies?
I assume, if you have a separation agreement, Mark, you probably worked with a family lawyer to draft it. I encourage you to seek input on the risks of moving out of your home and keeping your name on the house and mortgage.
Even if your plan seems like a good short-term solution, you should try to work towards a long-term plan to divide your assets.
Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto. He does not sell any financial products whatsoever. If you have a question for Jason, please send it to firstname.lastname@example.org.