Q: Do I have to pay income tax if I inherited a property jointly with my sister and she bought me out for less than half the appraised value of the property?
A: Asset sales between family members can be tricky to facilitate at a family level, let alone from a tax perspective. There are tax implications to be aware of here, Johanna.
First, a primer on how capital gains tax works. For real estate, it’s based on the sale price, less selling costs, less capital improvements made to the property, less your adjusted cost base (ACB) or acquisition cost.
Fifty percent of a capital gain is taxable and is added to your other sources of income for the tax year. A large capital gain—for example, on a piece of real estate—can easily push you into a higher tax bracket.
There are nuances related to real estate like whether or not a property might qualify as a principal residence, whether a capital gains exemption was declared in 1994 if you inherited prior to that and so on that you also need to consider.
In your case, Johanna, because you inherited the joint property, your adjusted cost base or acquisition cost should be one-half of the fair market value as of the date of death of the person you inherited the property from initially. They would have been deemed to have sold the property at fair market value on their death—a so-called deemed disposition. If the property was not their principle residence, they would have paid tax on their capital gain, if applicable, at that time.
So if you are not sure of the value at the time of your acquisition, you could generally determine this from the deceased’s final tax return or estate information return for probate purposes where this value would be listed.
A sale of property to a family member or someone who you are not dealing with at “arm’s length” generally takes place—for tax purposes—at fair market value. This is the case even if you legally sell it for less than the fair market value, as was the case with your sister. So using an artificially low sale price won’t negate the capital gains tax. Capital gains will be calculated based on the fair market value price, Johanna.
If you have recently inherited the property, it may be that the current fair market value of the property and your adjusted cost base are roughly equal, meaning little or no capital gains tax payable. However, if it’s been a year or more, there’s a good chance that the value has increased based on the performance of many Canadian real estate markets. A realtor may be needed to perform a market value analysis and give you your fair market valuation.
I’m not sure what the motivation was for selling the property at a discount to your sister, Johanna. If it was pure generosity, that’s nice of you, but you still may have tax to pay. Given your charitable intention, you should probably get a donation receipt! But you won’t, of course.
If the capital gain is a large one and you don’t need the funds, you may consider splitting the receipt of funds from your sister over a period of up to five years, if it’s not too late. When you do this, you may be able to claim a capital gains reserve and split the capital gain over up to five years and potentially pay less tax. Whether or not this is possible or even worth it is a matter of fact.
In summary, there may be capital gains tax payable on the sale of the home, despite the discounted price, Johanna. This reinforces why it’s advisable to solicit tax advice in advance of undertaking these sorts of transactions to ensure that you understand all of the facts and how best to plan accordingly.
Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto, Ontario. He does not sell any financial products whatsoever.