How can couples avoid capital gains tax on property in Canada?

• One spouse owned a property before the marriage, and the property title is left in their name only. 
• One spouse owns a business where they face a lot of liability. The property title may be registered in the other spouse’s name for creditor protection purposes. 
• In a second marriage, a couple might own real estate as tenants in common, so that when they die, their individual shares of the property go to their children from the first marriage. 

It is unclear why the rental property is just in your husband’s name, Iuliana. But there are a number of considerations we can address.

Converting a principal residence to a rental property

When you have a principal residence and you change the use of the property, you are deemed to have sold it at the fair market value at that time and to have immediately reacquired it at the same value. This may result in a capital gain or loss in the year the use changes, and this may have tax implications.

If the property qualified as your principal residence for all the years of prior ownership, there will be no tax payable. So, converting it to a rental property would have established the adjusted cost base for future capital gains tax. That is, unless you filed a subsection 45(2) election with the Canada Revenue Agency (CRA) at the time to continue to designate the property as your principal residence for up to four additional years. You may even be able to file this election retroactively.

The conditions for this 45(2) election require that you cannot designate any other real estate as your principal residence during those years, and you cannot claim any capital cost allowance (CCA)—or depreciation—against the net rental income reported on your tax return. You must also remain a resident or deemed resident of Canada. A case where you might do this is when you move into a home that you are renting, but you keep a previous home as a rental property. It may not be common, but it happens.

In some cases, you may be able to extend this four-year limit indefinitely if you live away from your principal residence because your employer, or your spouse’s or common-law partner’s employer, wants you to relocate.

Capital gains tax when the first spouse dies

When a taxpayer transfers assets to their spouse, Iuliana, those assets transfer at the original adjusted cost base by default. If this transfer is done during one’s lifetime, any subsequent income, including capital gains, are attributed back to the transferring spouse. (See my earlier column about the tax implications of giving your spouse money or assets to invest.)

When someone dies, if they leave their assets to their spouse, the same transfer at cost can apply. However, subsequent income is not attributable back to the first spouse. Subsequent capital gains can be taxed to the spouse who inherited the asset. As a result, there may be no capital gains on the death of the first spouse, so no tax payable by your husband when he dies if he leaves the rental property to you, Iuliana. Instead, you would pay all deferred capital gains when you sell the property, or you die and you are deemed to sell it.

The executor of the estate of the deceased can elect to trigger a capital gain on death for some or all of the deferred capital gain. This may be done if the deceased died early in the year and had little to no income, or if they have capital losses or other tax deductions or tax credits available to claim. These may be reasons to claim a partial or full capital gain by electing the transfer to happen at a value that is above the cost base up to the fair market value. The value elected would then become the cost base for the inheriting spouse, thus reducing their future capital gains.

Joint legal ownership vs. joint beneficial ownership

There is a distinction between legal and beneficial ownership when an asset is owned jointly. 

• Legal ownership refers to the name or names on title for a real estate property. A property in your husband’s name, Iuliana, is legally registered to him.
• Beneficial ownership refers to whose property it was technically, and more specifically, from a tax perspective.

If you both contributed equally to the purchase and mortgage payments for the home while it was your principal residence, it could be that the property is jointly owned beneficially, despite being legally in his name. But you would also want to consider whose tax return the rental income was reported on after converting it to a rental property. If it was always reported on your husband’s tax return, the two of you have already taken the position that the property is beneficially—and legally—his.

People sometimes get confused because the family law treatment of marital assets can differ from that of legal and beneficial ownership. The rules vary by province or territory and depend on the circumstances, but an asset can be legally and beneficially owned by one spouse, and in the event of a divorce, the same asset may be subject to division.

Probate when the first spouse dies

Probate is the process of validating a will to allow the executor to distribute the assets to the beneficiaries. In the case of real estate, probate may be required to permit a lawyer to transfer the ownership to a beneficiary. Probate may also come with fees or taxes payable to the province or territory.

In some provinces or territories, the probate costs are hundreds of dollars, and in others, up to 1.6% of the value of the assets passing through a will.

If the ownership of this property is just in your husband’s name, Iuliana, probate may be payable on his death to transfer the asset into your name.

You may be able to avoid probate by having the property registered jointly in both your names. And going back to the concept of legal versus beneficial ownership, despite registering it legally in both names, your husband could continue to report the income on his tax return. Beneficial ownership could remain with him, while legal ownership—and the subsequent opportunity to avoid probate—would be changed.

Capital gains tax and probate when the second spouse dies

People are often confused about the differences between a taxpayer owning real estate jointly with their spouse versus with another person like their child. On the second death of a couple, capital gains tax applies, and probate may apply.

Owning an asset jointly with your children does not avoid capital gains tax. The same tax-deferred transfer does not apply between a parent and a child. This is only available between spouses. So, on the second death, there would be a deemed disposition at the fair market value with all deferred capital gains brought into income on the final tax return of the deceased.

Probate is a little more challenging. Joint ownership with a child may or may not avoid probate and has significant risks. You should speak to an estate lawyer to understand whether an asset owned jointly with a child may avoid probate. And consider whether saving hundreds or thousands of dollars is worth putting an asset worth hundreds of thousands or millions of dollars at risk.

Summary

To wrap up, Iuliana, your husband can add your name to this rental property now without tax implications. Whether he does or not, the property can be transferred to you on a tax-deferred basis on his death from the perspective of capital gains tax. If you are not on title as a joint owner with right of survivorship, the property may, however, be subject to probate with modest costs involved upon his death.

Read more about estate planning:

• How to avoid probate fees in Canada
• Can transferring ownership of a house help avoid probate tax?
• Is transferring your principal residence to your corporation a good idea?
• Capital gains when selling property to family
• Capital gains, taxes and more: The implications of inheriting real estate

About Jason Heath, CFP

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.

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