The article “How capital gains tax on property is divided in a divorce” was originally published in MoneySense on August 15, 2022. Photo by Andrea Piacquadio from Pexels.
When a couple separates, how does owning, transferring and dividing multiple properties affect capital gains?
My spouse and I separated in September 2020. I am the only one on title for the matrimonial home, and we are both on title for two jointly owned investment condos. He currently lives in one of the condos (condo A), but he plans to move to condo B and buy me out with the equity in condo A. We would then sell condo A. I think he’s likely setting himself up not to pay any capital gains tax by doing this. I’m wondering what planning I can do to minimize my own capital gains tax based on the rules. – Kay
Tax implications of transferring an asset to a spouse
When you transfer an asset to a spouse, there are generally no immediate tax implications. By default, the asset transfers at its adjusted cost base (or the undepreciated capital cost for depreciable property) with no capital gain triggered, unless you elect otherwise.
There may be subsequent tax implications due to the spousal attribution rules, however. Future income—like dividends, interest, rental income or capital gains—may be attributed back to the transferring spouse and taxed to them.
In the event of a separation or divorce, Kay, the same tax-deferred rollover can apply if the transfer is made as part of a separation or divorce settlement. This applies for both common-law and legally married spouses. The attribution rules no longer apply after a relationship breakdown either, so the receiving spouse is responsible for future income tax.
What this means in your case, Kay, is that you and your ex-husband can transfer ownership of the three properties between each other as part of your divorce settlement without triggering capital gains tax. You mentioned that one of the three properties is in your name and the other two are jointly owned. This tax-deferred transfer option would apply for all three properties, regardless of whose name(s) a property is in and which of you receives the transfer.
Now that we have determined that no immediate capital gains tax implications will result unless you elect otherwise, we need to consider what capital gains tax may apply to one or both of you in the future.
Can you avoid capital gains tax in a divorce?
The principal residence exemption allows a couple to claim an eligible property as their tax-free principal residence for a particular tax year. An eligible property is one that a couple ordinarily inhabits. It can include a cottage, vacation property or other property that may not be their main residence or place where they mainly reside.
You and your ex-husband, Kay, own a home and two investment condos. Assuming the two investment condos have been rental properties, there is deferred capital gains tax to the extent they have appreciated in value. You and your ex-husband may only be able to claim the principal residence exemption for your home, assuming you have not done so for any other property you both owned previously during the years you’ve owned your matrimonial home.
If your husband moves into one of the investment condos, that act alone will not be enough to negate the deferred capital gains tax. Moving into an investment property and selling it does not allow you to claim the principal residence exemption and avoid tax on historical appreciation. In fact, moving into it may trigger capital gains tax to become payable since the property is subject to a change in use from income-producing to personal use. This results in a deemed disposition or notional sale of the property at the fair market value.
Your ex-husband may be able to defer the income inclusion of the capital gain on an investment condo he moves into by filing a subsection 45(3) election within 90 days of Canada Revenue Agency (CRA) requesting he make the election or by the filing deadline of his tax return for the year he sells the property. This election would only be valid if you and your ex-husband have not claimed capital cost allowance (depreciation) on the condo in the past.
So, while your ex-husband may be able to shield future appreciation in the condo’s value, the appreciation to date will be considered a capital gain and subject to future tax.
Dividing assets and liabilities in a divorce
Generally, as part of a separation or divorce, you value your assets and liabilities and determine how they are to be split. The liabilities should include deferred taxes on investment properties and other tax-deferred assets.
You and your ex-husband, Kay, may agree to split the capital gains tax on the investment condos. Or if he takes those assets on a tax-deferred basis, your share of assets may be adjusted accordingly to reflect the deferred tax liability.
In summary, here is how dividing and transferring properties during a separation or divorce can affect you, your ex and your tax situations:
- You can likely both claim a principal residence exemption for your matrimonial home to avoid capital gains tax, assuming you have not claimed any other property as your principal residence during the years you have owned it.
- The investment properties can be transferred between you and your ex-husband on a tax-deferred basis.
- If your husband moves into one of the investment condos, the capital gains tax on that condo can be deferred. The capital gains tax on the other investment condo will be triggered upon its sale.
- An investment condo can become your ex-husband’s principal residence for tax purposes, but this only saves tax on the property’s future appreciation, from the time he moves into it.
- The capital gains and other deferred tax liabilities on your family assets are typically considered as part of a separation or divorce settlement. A family lawyer would help with this process as part of your equalization calculation.
Good luck getting everything sorted out with your ex-husband, Kay.
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.