Transfers and loans to family members
Transfers to a spouse or common-law partner
All capital properties, such as shares in companies and real estate, are automatically transferred between spouses or common-law partners on a tax-free basis. If you want the transfer to take place at FMV, you must file a special election requesting this treatment when you file your tax return for the year of the transfer.
When the transferred property is eventually sold to a third party by your spouse or common-law partner, you’ll have to report any capital gain or loss realized on the sale unless all of the following conditions are met. First of all, your spouse or common-law partner must have paid FMV for the property at the time of the transfer. You must also have made the FMV election (as noted above), and sufficient annual interest on any unpaid purchase price must have been paid in full no later than January 30 of the following year. If all of these conditions have been met, any subsequent capital gain or loss realized on a sale to a third party can be taxed in your spouse or common-law partner’s hands (rather than in your hands).
Example: In June 2016, you decide to transfer your shares of XYZ Co. to your spouse. You acquired the shares in 2000 at a cost of $1,000 and they have a current FMV of $6,000. For tax purposes, your spouse will be deemed to have acquired the shares from you at a cost of $1,000. Therefore, you won’t recognize a capital gain or loss on the transfer. However, you’ll be taxed on any capital gain or loss that results when your spouse disposes of the shares (based on an original cost of $1,000).
Alternatively, by attaching a note to your tax return, you may elect to have the transfer to your spouse take place at FMV. As a result of making this election, you’ll report a capital gain of $5,000 and your spouse will be deemed to have acquired the shares from you at a cost of $6,000. If your spouse paid you $6,000 for the shares (say, by way of a loan from you) and the shares are subsequently sold for $8,000, the $2,000 gain would be taxable in your spouse’s hands—provided your spouse pays a reasonable rate of annual interest on the loan within the required time period.
Special rules apply in situations where the property has been transferred between spouses or common-law partners as part of a property settlement or where the couple is separated when the property is sold to a third party.
Tax tip: With current interest rates at fairly low levels, you might want to consider an income-splitting loan to your spouse or common-law partner. The attribution rules won’t apply if you are paid interest on the loan at the prescribed rate in effect at the time the loan is made. For example, the prescribed rate in effect for the third quarter of 2016 is 1%. This rate will remain in effect for as long as the loan is outstanding—even if rates increase in the future.
In implementing any income-splitting strategy, you have to be careful if you want to avoid the attribution rules. In situations where property is transferred to your spouse or common-law partner, attribution can apply to both income and capital gains. Contact your tax adviser to discuss the steps you need to take to accomplish this or other income- splitting strategies.
Transfers to other family members
A transfer of capital property to other family members is taxed just as if you sold the property at its FMV. If the property has been transferred to a child, grandchild, niece or nephew, you must continue to report any income earned on such property after it has been transferred—such as interest or dividend income—until the child reaches 18 years of age. After 18, attribution no longer applies and that individual must report the income. Capital gains, on the other hand, do not have to be attributed to you (regardless of the age of the child). This can be a useful income-splitting tool. However, make sure that any capital gain realized by a minor child is not subject to the “kiddie tax” rules
Tax tip: Unless the person receiving the property is your spouse or common-law partner, there is no requirement to attribute capital gains to you, the transferor. Consider buying in the names of your children capital property (such as equity-based mutual funds) with a low yield but high capital gains potential. The income will be attributed to you, but any future capital gains will be taxed in your children’s hands.
Tax tip: The deemed cost base of property received as a gift or inheritance is its FMV at the time of transfer. However, if you charge a nominal amount for the transfer of property— for example, $10—you’re deemed to receive FMV for the property, but the recipient’s cost base remains at $10. Therefore, it’s better to gift property than to charge a nominal amount, since the recipient will receive the full increase in the cost base.
Interest-free loans to family members
Caution should be exercised if you provide low-interest or interest-free loans to family members, either to enable them to purchase income-producing assets or as consideration for the transfer of assets. If one of the main reasons for the loan is to reduce or avoid tax, you must report any income earned on the property, regardless of the age of the loan recipient. An outright gift to a child who is 18 years or older—or anyone other than a spouse or common-law partner—is not subject to this rule.