Can you move income back and forth between spouses?

Let’s look at reporting investment income and capital gains, and which spouse should report the capital gain on a rental property. 

Reporting investment income

When you earn investment income like interest or dividends in a taxable investment account, or rental income from a rental property, you need to report it on your tax return.

Taxpayers sometimes mistakenly think they can minimize the tax payable by choosing which spouse’s tax return to report the income on, and in some cases, changing the allocation from year to year. Unfortunately, it does not work that way. The income must be reported by the spouse who earned it. If the asset is truly joint, each taxpayer would report their proportionate share of the income on their tax return.

Reporting capital gains

Like other sources of income, capital gains have to be reported by the person who earned the income. If the capital gain is on a property held in your name only, Zlatko, you cannot report half the capital gain on your spouse’s tax return to reduce tax, nor can you use their registered retirement savings plan (RRSP) room to reduce the taxable income.  

Presumably, you have been reporting 100% of the rental income on your tax return annually, so to change that reporting suddenly when there is a big income inclusion from the capital gain is not an option. If you were reporting the income incorrectly all along, and it should always have been reported jointly, you should go back and adjust your tax return and your spouse’s tax return. Interest would apply on your spouse’s balance owing, and you would receive a refund. But you should have a good reason for the oversight, as the Canada Revenue Agency (CRA) does not like this sort of “convenient” retroactive tax planning.

Legal versus beneficial ownership

You mentioned that the property is in your name. For tax purposes, there is always a distinction between legal ownership and beneficial ownership. 

An asset can be legally owned by one spouse but beneficially belong in part or in whole by the other. If you both contributed equally to the down payment for the property, for example, you should report the capital gain equally, despite the property being held in your name alone, Zlatko.

However, if this was inconsistent with the past reporting of the rental income, that means you may have been reporting the property incorrectly all along. It does not sound like this is the case for you.

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Spousal attribution

On the other hand, if your spouse gave you the money for the down payment, so that the property technically belongs to them beneficially, the income may be subject to attribution. If both spouses have contributed differing amounts at different times, it can be more complicated to determine beneficial ownership for tax purposes. It bears mentioning that spouses can own an asset in a proportion other than 50/50 as a result.

Spousal attribution is when income is earned by one spouse, but because of the source of the funds that generated the income, that income gets taxed back to the contributing spouse.

If your spouse actually bought this rental property in your name to try to reduce tax, it may be that the capital gain and all the past rental income should technically be taxed to them, Zlatko. 

Transferring assets between spouses

Sometimes, people ask me about transferring an asset to their spouse, or adding their spouse’s name to the property prior to selling it. A transaction like this runs into the same spousal attribution issue, where an asset you own, transferred to your spouse, will have resulting income taxed back to you.

As a result, you cannot transfer partial ownership to your spouse in an attempt at last-minute tax planning.

Tax reduction options

You brought up contributing to your and your spouse’s RRSPs, Zlatko. This is definitely one way to reduce your taxable income in the year you sell the property. If the capital gain is large, or your income is relatively high besides the capital gain, you may be able to offset about $2 of capital gains with every dollar contributed to your RRSP.

This is because only half of a capital gain is taxable. So, you would only need a $50,000 RRSP contribution to fully offset a $100,000 capital gain.

If you can control your income in the year of the capital gain by reducing or avoiding other sources of income, you may be able to mitigate some of the tax payable on the capital gain, as well. For example, if you are a business owner who can lower your salary or dividends, or you can defer other capital gains or registered account withdrawals, or you can claim or accelerate other tax deductions.

In most cases, though, the practical or strategic timing of the property sale should be the priority, with the tax implications being a secondary consideration. Tax is important, but it should not be the primary factor when making an investment decision.

More about capital gains:

• How it works: Capital gains tax on the sale of a property
• Capital gains tax in Canada, explained
• How can couples avoid capital gains tax on property in Canada?
• Reducing capital gains on a cottage
• How to handle a stock with a huge capital gain

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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