In accordance with Canadian tax legislation, a built-in provision for tax deferral comes into play when assets are transferred between spouses who are residents of Canada. This provision enables the transfer of assets at their original cost, thereby delaying any tax consequences associated with the transaction until the receiving spouse decides to sell the transferred property. However, there are various situations in which a taxpayer may want to elect out of this automatic rollover.
How does the automatic interspousal rollover work?
When a taxpayer transfers an asset to their spouse, they are disposing of that asset for Canadian income tax purposes at cost on an automatic rollover basis (“automatic rollover”). This means that if there is an accrued gain or loss due to the market value of the asset being greater or less than the cost of the asset, there will be no gain or loss that will arise on the transfer, resulting in no taxes payable at that time.
This could be beneficial for taxpayers who have an accrued gain on their asset as it allows the gain to be deferred until the spouse who receives the asset disposes of it. However, taxpayers should be aware of attribution rules that may apply, resulting in any income earned and gains incurred on the asset being attributed back to the taxpayer who made the transfer, such that it will be taxable to the transferor.
The automatic rollover is not always beneficial for taxpayers and their goals. Tax legislation provides taxpayers with an option to elect out of the automatic rollover (a formal election is required to be filed).
Situations where a taxpayer might consider opting out of the automatic rollover
- To prevent the attribution rules from applying and achieve income splitting on a go-forward basis
The attribution rules lead to a situation where any income earned, and gains incurred on the asset transferred between spouses are taxed based on the transferor spouse's tax rate. This counters the strategy of income splitting planning, which aims to take advantage of the lower income tax bracket of the transferee spouse.
To achieve the goal of splitting income, the taxpayer would want to elect out of the rollover and transfer the property to their spouse at fair market value so that any future income or gains accrued on the property will be taxed in the hands of the transferee spouse. It is important that the transferee spouse provides fair market value consideration (i.e., cash, or an interest-bearing loan that meets certain requirements) to the transferer spouse for the property to ensure the attribution rules do not apply. The disadvantage of this planning is that there would be immediate taxes to the transferor spouse on any accrued gains on the property at the time of the transfer.
- To use the accrued gain on the asset against other capital losses
If a taxpayer has existing capital losses from other assets they would like to utilize, transferring an asset with an accrued gain to their spouse and electing out of the automatic rollover would allow the transferor spouse to offset existing capital losses against the accrued gain without having to sell the asset to a third party. The transferee spouse would have a stepped-up cost in the asset going forward.
- To take advantage of the lifetime capital gains exemption on shares with an accrued gain that meet the relevant criteria
If a taxpayer would like to take advantage of their lifetime capital gains exemption to shelter the accrued gain on their qualifying small business corporation shares from being taxed, he or she can transfer their shares to their spouse and elect out of the automatic rollover to trigger the gain. Taxpayers may want to elect out of the rollover to be able to crystalize their lifetime capital gain exemptions. The transferee spouse would have a stepped-up cost in the shares going forward and may be able to utilize their own lifetime capital gains exemption on any future growth in the shares. However, before undertaking such planning, there are additional factors that will need to be addressed to determine if such planning makes sense.
- In the event of a marital dissolution involving a matrimonial residence
In a marriage breakdown, the taxpayers may want to elect out of the automatic rollover so that the accrued gain on the property can be triggered and sheltered by the principal residence exemption. This allows the taxpayers to agree on the utilization of the principal residence exemption up to the point of marital breakdown; thereby allowing the principal residence exemption to be reset for both spouses on a go forward basis.
Where multiple properties are owned (i.e., a home and a cottage) the tax consequences will need to be analyzed as the principal residence exemption must be shared amongst the properties.
Is the automatic spousal rollover right for you?
As each person's circumstances are distinct and everyone has their own set of tax planning objectives, the decision of whether opting out of the automatic rollover is advantageous can only be evaluated case by case. To help achieve your goals in the most tax-efficient manner, we encourage you to reach out to your Crowe Soberman advisor.
This article has been prepared for the general information of our clients. Please note that this publication should not be considered a substitute for personalized advice related to your situation.