Tax consequences of owning property jointly

Moving property from sole ownership into joint ownership with a right of survivorship is a particularly seductive means of reducing exposure to probate taxes. It can often be done quickly and relatively inexpensively. However, such a transfer can represent a dangerous income-tax trap.

Under the Income Tax Act, when a person makes a non-arm’s length transfer of property to another person for no consideration, he or she is deemed to have received proceeds of disposition equal to the fair market value of the property at the time of that transfer. In other words, even if no money changes hands, the transferor will be taxed as if he or she was paid fair market value.

If the fair market value significantly exceeds the transferor’s tax cost, an immediate capital gain is triggered. (In the case of depreciable property, it will also give rise to an ordinary income inclusion equal to the amount by which capital cost allowance has been previously claimed.)

Determining whether two people deal with each other at arm’s length is not always a simple matter. However, the Income Tax Act does say that two people who are related by blood, marriage or adoption do not deal with each other at arm’s length. So a transfer between a parent and a child will be treated as a sale at fair market value, even if the parent is gifting the property to the child. (Even though spouses and common-law partners do not deal with each other at arm’s length, transfers between them will take place at the transferor’s tax cost — that is, on a “rollover” basis — unless the transferor elects to have the transfer take place at fair market value.)

In some cases, the Income Tax Act will give the transferor shelter against any resulting capital gain. Some examples:

• Where a parent transfers to a child a one-half interest in qualifying small business corporation shares, the parent will be able to offset the capital gain realized by any unused portion of his or her $750,000 lifetime capital gains deduction.
• Where a parent transfers to his or her child a fractional interest in a principal residence, the resulting capital gain can be sheltered under that parent’s principal residence exemption. (While the principal residence exemption may shelter all of the capital gain, the parent must be wary about the loss of a portion of the principal residence exemption on any increase in the value of the property after the date of the transfer – unless the child uses the property as his or her own principal residence.)

The income tax consequences of a disposition of property are triggered only when there is a change in beneficial ownership. A change in legal title without a corresponding change in beneficial ownership will not be recognized as a disposition that gives rise to proceeds of disposition in the hands of the transferor. So, for example, there will be no deemed disposition if a parent puts a child on title to a house, intending that the child acts as a bare trustee for the parent. Whether that arrangement will reduce probate taxes is a matter for another discussion.

Barry S. Corbin, B.Sc., M.Sc., LL.B. is a lawyer with Corbin Estates Law.