Introduction – Attribution Rules and Inter-spousal Property Transfers
This article is part three of the five parts “Election Series”. In this piece, the attribution rules that apply to inter-vivos transfer of property between spouses and the resulting tax consequences are discussed.
In the Canadian taxation system, spouses and common law partners are taxed as individuals: the couple do not report their household income as a unit. Instead, each spouse or common law partner reports the income that he earns personally.
There are exceptions to this rule. If the Income Attribution Rules of the Income Tax Act apply, the income earned or capital gain or loss realized from the property owned by one spouses is attributed to the other.
The Attribution rule is triggered when there is a below fair market value transfer of a property from one spouse to another. Although this is the default treatment of such transfers, the spouses can elect for an alternative treatment of such transfers.
Underlying Rationale of the Attribution Rules
Parliament’s rationale in implementing the attribution rules as a default position is simple. Transfer of property between spouses may result in a change in the legal title. However, from the perspective of the government, although the legal title has changed, the beneficial owner of the property (i.e. the family that the transferor is a member of) has not changed. Therefore, parliament has determined, as a default position, there should be no immediate tax consequences arising from the disposition of property from one spouse to another.
This rationale explains the tax consequences following the transfer of a property. Once the spouse who receives the transferred property sells it to an arms length party, any capital gains or losses generated are attributed back to the spouse who first owned the property. Additionally, any income generated following the transfer is also attributed back to the transferring spouse.
For example, if a wife transfers the title of a cottage to her husband and the husband subsequently sells the cottage to a third-party buyer, the sale likely results in capital gains or loss, unless the principal residence exemption is claimed. Any capital gain generated is attributed to the wife and she (and not the husband) must now recognize and report this amount to the CRA.
Attribution of Capital Gain following Transfer of Property between Spouses
No Tax Consequences for Transfer of Property between Spouses
Under section 74.1 of the Income Tax Act, there are no immediate tax consequences following the transfers of a property from one spouse to another.
For example, if a husband transfers the title of the family cottage to his wife, the husband is deemed to have sold his property to his wife for its adjusted cost base. The wife is deemed to have acquired the property for the husband’ adjusted cost base. Therefore, the husband does not recognize any capital gain or losses from the transfer of title of the cottage to his wife. The wife’s adjusted cost base is that of her husband and when she sells the cottage to a third party, any gain or loss are calculated using the husband’s adjusted cost base for the cottage.
Disposition of Transferred Property Triggers Attribution Rules
Generally, when a spouse sells the gifted or transferred property to a third party, the resulting capital gain is attributed back to and must be reported by the person who transferred the property.
In the previous example, the attribution rule is triggered when the wife sells the family cottage to a non-arm’s length party. Any capital gain realized from the sale of the cottage is attributed back to the husband. It is the husband, and not the wife (even though she is the person on title) who has to report the capital gain.
More planning is required when the transfer of properties that is disposed of is in a loss position. The person who has transferred the property may be unable to use the resulting capital loss to reduce his gains because of the application of superficial loss rules.
Attribution of Income following Transfer of Property between Spouses
Under section 74.2 of the Income Tax Act, any income that is generated following the transfer of property from one spouse to another is attributed back to the person who transferred the property. The income is not deemed to be earned by the person who “owns” the property or is on title for it.
For example, a wife may transfer her dividend yielding portfolio to her husband so that he is listed as the legal owner of the equities therein. There are no immediate tax consequences to this transfer. However, reporting obligations are triggered when the portfolio generates income. Even though the husband has legal title to the portfolio, any income generated is attributed to the wife. She has to report this income when she files her taxes. Not the husband.
Tax Tips: How To Remedy Failure to Report Attributed Income
It is important to note that failure to report attributed capital gain or income gives rise to unreported income. A taxpayer’s failure to remedy this can attract penalties if it is first discovered by the Canada Revenue Agency. It is important to seek advice from an experienced Canadian Tax Lawyer to determine your eligibility for a voluntary disclosure program in these circumstances.