Does transferring property such as a cottage to joint ownership with children trigger capital gains tax?

Sean Rheubottom, B.A. LL.B., TEP

Joint ownership is a bit strange. For legal purposes, in a “true” joint ownership arrangement, each joint owner (sometimes called a “joint tenant”) owns 100% of the property, sort of like a partner. What happens if one of them dies? How does ownership change hands? Do probate fees apply?

What about tax consequences?

There’s a common misconception that “adding” a child of yours as a joint owner will never trigger a capital gain with respect to the property. It’s more accurate to say that usually, it will trigger some amount of capital gains, if there are gains inherent in the property.

The tax rules don’t care so much about the legal niceties of joint ownership. The tax man prefers simply to count the number of “joint” owners, and call them part or fractional owners, so that if there are two, they each own 1/2, and if there are three, they each own 1/3, and so on, unless there is evidence showing otherwise.

To simplify this discussion, let’s assume it’s impractical to use the principal residence exemption on this property because it will be needed for another property. Also, we’ll assume that no farm rollover could apply on the land.

The following deals with “true” joint ownership, as well as the more “special” kinds of joint ownership that came into being partly as a result of a Supreme Court of Canada case, Pecore, that was decided in 2007.

Why is joint ownership so popular?

The usual aim is to avoid probate fees. A lot of the hype about probate fees comes from Ontario where probate fees are much higher than they are here in Saskatchewan.

 In Saskatchewan, probate fees cost a relatively inexpensive $7 for every $1,000 of estate value. Joint ownership, where there is a true right of survivorship, avoids this expense because ownership transfers automatically without passing through the estate of the deceased.

This can amount to a meaningful saving in some cases, but when potential legal and tax complexities are involved, sometimes joint ownership isn’t worth the trouble. 

We’ll look at the legal problems that can result in an upcoming article. Right now, let’s focus on tax.

“True” joint ownership

The typical intention with joint ownership is to create what is often called a “true” joint ownership arrangement.

If it is a “true” joint ownership, it means “joint with right of survivorship” the way we normally understand joint ownership. If one joint tenant dies, the other automatically owns the property or the interest therein.

Tax consequences: “true” joint ownership

If at the time of the transfer of a joint interest from one parent (Parent”) to that Parent and one child (“Child”), the intention was “true” joint ownership, then for tax purposes Parent would be treated as having disposed of 50% of the property for proceeds equal to the fair market value (FMV) of that 50%.

If Child paid Parent no proceeds for Child’s joint interest, Parent would have a taxable disposition at FMV of the 50% interest, and Child would have full cost base (“adjusted cost base” or “ACB”) in Child’s joint interest.

So, for example if the property was worth $120 with a cost base of $20, at the time of the transfer Parent would be deemed to have sold for FMV proceeds a property worth $60 with ACB of $10, realizing a capital gain of $50.

Child would receive an interest with FMV of $60 and ACB of $60.

If Child paid Parent less than FMV proceeds, Parent would still have a taxable disposition at FMV of the 50% interest, but Child’s ACB would be limited to the amount Child paid – for example let’s say Child paid $10. Double tax would eventually result when Child later sells Child’s interest in the property.

In this case Parent would have a capital gain of $50 as with the previous example, but Child would receive an interest with FMV of $60 and ACB of only $10. Child would realize that capital gain of $50 on a later sale even though Parent was already taxed on that gain.

So, it might be said that a gift for no proceeds is better tax-wise than a sale at less than FMV. Have you ever heard about a clever plan to sell the cottage to a child for $1? Not so clever in view of the above.

If this were a rental property on which capital cost allowance (CCA) was claimed, it is possible that the tax consequence could include recapture of CCA as well as a capital gain.

“Resulting trust” joint ownership

Sometimes the intention is to create a “resulting trust” joint ownership arrangement in which the child who is the joint owner does not get a beneficial ownership interest on the transfer but only holds the property in trust on the condition that he or she will distribute it in accordance with the Will of the deceased Parent. In this arrangement, there is not a gift of a beneficial interest in the property when the Parent transfers the joint interest to the child.

However, Saskatchewan case law and legislation does not favour an easy finding of this fancier arrangement at least with regard to real property. It’s generally more likely that there was a “true” joint ownership arrangement (with the attendant tax consequences described above) and the child simply gets the land automatically by survivorship when the parent dies.

With other kinds of property such as financial accounts, there is perhaps less of a legal hurdle to overcome to create a “resulting trust” arrangement, but clear evidence is still required as described below.

Despite the law’s reluctance, a “resulting trust” intention can be found to exist where there was clear evidence of such an intention made at the time of the transfer. Examples of such evidence would be a clearly worded written deed of gift or a written trust deed clearly spelling out the intention.

The most important evidence of intention is evidence that existed at the time of the transfer. The court in one case took note of the fact that the mother did not report any taxable disposition on the transfer to a child, which would seem to favour an intention to create a resulting trust. The court noted that there should have been a taxable disposition if there was a real transfer to true joint ownership. Nonetheless the court still found that there was a transfer to true joint ownership. There was no indication of how the mother worked things out with CRA.

Tax consequences of transfer if there is really a resulting trust

CRA acknowledged long ago that the creation of a joint tenancy in which no beneficial ownership interest is conveyed would not result in a disposition for tax purposes. However, the effectiveness of such a strategy to reduce probate fees is questionable (unlikely). It would be hard to have it both ways, avoiding both a taxable disposition and probate fees.

“Gift of right of survivorship” joint ownership

Because of some “obiter” or non-decisive comments from the Supreme Court of Canada in a case (Pecore) decided in 2007, there is a newer concept sometimes described as a gift of the right of survivorship. It appears that it may be possible to make a gift of just the right of survivorship, while completely retaining beneficial ownership during life. This idea can seem confusing. To me at least.

For the reasons stated above regarding “resulting trust” joint ownership, it seems doubtful that such an arrangement would be found to exist in Saskatchewan for real property, except if there is clear evidence supporting it, in existence at the time of the transfer.

The hope with this arrangement is that it avoids probate fees on the death because the joint ownership registration on the title allows the land titles office to treat it as a simple automatic transfer of a joint interest to the surviving joint tenant.

Tax consequences: “Gift of right of survivorship"

It appears that neither the courts nor CRA have commented on the tax effect of this arrangement. Some estate and tax lawyers advise caution about thinking that this arrangement will defer tax on the transfer. However, in situations where it has been made very clear that there was no transfer of beneficial ownership at the time of the transfer, it would be hard to believe that there has been a disposition for tax purposes.

Legal issues, and “tenancy in common”

More later about the legal consequences, and that other arrangement we didn’t discuss, known as “tenancy in common”. 

Be sure you are working with experienced tax and legal advisors when considering these options. Expect your various financial, legal and tax advisors to work as a team to get you the best results.

© Heritage Private Wealth Law

General information only; not intended as legal or tax advice. Readers are encouraged to obtain legal and tax advice before acting in their specific circumstances.