Read Part 2 of this series here. Editor’s note: While this article was published in 2013, the author has confirmed that it is current for the 2016 tax year.
When clients separate or divorce, they may not think about taxes when dividing property.
Yet the impact of income taxes shapes the size and type of assets that are transferred between spouses. So, carefully consider them when splitting assets as part of an equalization payment.
The settlement in a divorce or separation often requires transferring assets between spouses or common-law partners.
For income tax purposes, the transfer of assets such as non-registered financial investments (shares of private or public companies, mutual funds, etc.) or real estate (including a matrimonial home or recreational property) generally takes place at the adjusted cost base (ACB), meaning no tax is triggered when an asset is transferred between spouses. This is often referred to as a rollover.
The recipient of an asset is generally taxed at the time he or she ultimately sells or disposes of the asset (including a deemed disposition upon death) based upon the difference between the ACB of the asset and its fair market value at the time of transfer.
This tax-deferred rollover provision applies automatically unless the parties decide to transfer an asset at its fair market value, thereby triggering a capital gain upon transfer.
This election would benefit the transferring party if he or she has unused capital losses available to offset those capital gains.
Tom plans to transfer to Katie a $100,000 non-registered mutual fund portfolio due to their marriage breakdown. Tom purchased the funds a number of years ago and has an adjusted cost base (ACB) of $50,000. Tom also has unused capital losses from previous years of $50,000.
With no tax planning, the transfer will occur at Tom’s ACB ($50,000), which will result in no immediate tax liability for Tom. Katie will inherit Tom’s ACB upon the transfer and thus own the $100,000 portfolio with an ACB of $50,000.
Assuming Katie sells the portfolio in the future for $120,000, she will incur a tax liability of approximately $15,750, assuming a 45% marginal tax rate ($120,000 – $50,000 x 50% inclusion rate x 45% tax rate).
However, if Tom files an election to not have the automatic rollover provisions apply, he can transfer the mutual fund portfolio at its current fair market value ($100,000) and trigger the $50,000 capital gain.
Since he has unused capital losses, he can apply them against this gain and the result again would be no taxation.
That also means Katie will inherit the portfolio with an ACB of $100,000 (instead of $50,000). When she sells the portfolio in the future for $120,000, her tax liability will be reduced to $4,500 ($120,000 – $100,000 x 50% inclusion rate x 45% tax rate).
RRSP and RRIF transfers
If some or all of the amounts in an RRSP or RRIF are being transferred between spouses or common-law partners as a result of separation or divorce, the transfer can take place on a tax-deferred basis on two conditions:
- the money being transferred remains in a RRSP or RRIF of the recipient spouse or partner, and
- the transfer is done pursuant to a court order or written separation agreement using CRA form T2220.
When the recipient spouse or common-law partner later withdraws money from his or her RRSP or RRIF, the full amount is taxable in that person’s hands at their marginal tax rate in the year of withdrawal.
So, in some cases it makes sense to transfer some or all of an RRSP or RRIF as part of equalization between spouses on relationship breakdown.
Specifically, RRSP transfers are a preferable way of satisfying equalizing obligations when there is a dramatic difference between the marginal tax rates of the spouses, particularly where the recipient spouse intends to draw income from the RRSP or RRIF at a future time when his or her taxable income is lower.