Parents want the best for their kids, and that often extends to giving away some of their assets in order to help their adult children get established in life. But while Canadian tax law renders gifts exempt from tax for the receiver, they can be taxable for the giver due to rules around capital gains.
Normally, a capital gain (loss) is calculated as follows:
Capital Gain (Loss) = sale price – purchase price
If you sell the asset to an arms’-length person, i.e., a stranger or a person with no close connection to you, you agree upon a sale price and that is the figure you use for this calculation. However, the rule is different for transactions between closely-related people.
If you give away or sell an asset (i.e., anything of value held as an investment) to a non-arms’-length person, e.g., an adult child or a spouse, the asset is considered to have been disposed of – sold – at fair market value or the sale price, whichever is higher.
Let’s look at an example. Sandra owns second house which she uses to generate rental income. She decides to give the second house to her son, Adam, and his new wife as a wedding gift. Adam doesn’t need to report the gift on his tax return or pay any tax on it; but because it had been an income-producing property for Sandra she must treat the home as if it were sold, and report the gain on her tax return.
Even if she drew up paperwork saying she sold it to Adam for a dollar, she wouldn’t be able to use that sale price to calculate her capital gain because the home was worth more than that. In transactions between non-arms’-length people, one must base one’s calculations on what the asset would have been worth on the open market at the time its ownership was transferred.
Note that the rule would also apply if Sandra left the property to Adam in her will: he would pay no tax upon inheriting it, but her estate would owe income tax based on the capital gain, calculated using the fair market value at the time of her death*.
Note: if Adam decides to keep using the house as an investment property, rather than his principal residence, he may need to do some tax calculations of his own. Learn more about tax on inherited property…
Parents transfer assets to their children for many reasons, be they simple acts of generosity, or part of an overarching tax strategy. But as with all things, the larger the transaction, the larger the potential tax implications. And CRA always gets their take.
If you’re contemplating a significant transfer of assets and need some insight as to the tax implications, contact us for a free consultation.
* In fact, all a person’s remaining assets are treated as if they’re sold at the moment of death, and taxed accordingly. Often this translates to a very high marginal tax rate (and very high taxes) in the year of death. For this reason, transferring assets to a descendant gradually over a period of years can significantly reduce tax compared to leaving those assets to the descendant in your will.