Overview
There are special rules under the Income Tax Act (the “Act”) that apply to transfers of property to a non-arm’s length person. The rules, discussed below, can override the actual proceeds or sales price received on the transfer.
For most purposes, “related” persons, as defined in the Act, are non-arm’s length persons.
With individuals, related persons and therefore non-arm’s length persons include the types of individuals you would normally consider related to you. For example, they include:
- Your spouse or common-law partner
- Your children, grandchildren, great-grandchildren, and so on
- Your parents, grandparents, great-grand parents, and so on
- Your siblings
- Your in-laws
Interestingly, they do not include aunts, uncles, cousins, and nieces and nephews. So the non-arm length rules do not normally apply to transfers of property to these individuals.
In terms of corporations, the rules are somewhat more complex. Some basic examples of related and non-arm’s length relationships include:
- You and a corporation that you control
- You and a corporation that you control with a related group of persons (say, you and your two siblings control a corporation)
- Two or more corporations, if they are controlled by the same person or group of persons
For these purposes, control typically means owning more than 50% of the voting shares of the corporation.
The rules that apply on transfers
One rule states that where you transfer a property to a non-arm’s length person for something more than zero, but less than the fair market value of the property, you are deemed to dispose of the property for proceeds equal to the fair market value of the property. But the rule is one-sided, in that the person acquiring the property gets a cost of what they actually paid you. As illustrated in the example below, this rule is punitive, and can lead to double taxation.
Example
I sell a property to my sister for $5,000, when the fair market value of the property is $15,000. My cost of the property was $5,000.
Under this rule, I will have deemed proceeds of $15,000, leading to a capital gain of $10,000, and half of that will be included in my income as a taxable capital gain.
But my sister’s cost is not bumped up to fair market value and is simply the $5,000 that she paid me for the property. So let’s say she sells the property to a third party for $15,000. She will have a capital gain of $10,000, and half of that will be included in her income as a taxable capital gain.
There is double taxation. Both I and my sister were taxed on the same capital gain.
Note: There is a major exception to this rule and the other non-arm’s length transfer rules, where you transfer the property to your spouse or common-law partner. This exception is discussed in the text below under the heading “Exception for transfers to spouse”.
Another rule applies where you transfer a property to a non-arm’s length person for more than fair market value. In this case, your proceeds on the sale remain whatever they paid you. But the purchaser’s cost of the property is ground down to its fair market value, even though they paid you more than that for the property. Again, this can lead to double taxation.
Example
My sister buys a property from me for $15,000, when the fair market value of the property is $5,000. My cost of the property was $5,000. So I will have a capital gain of $10,000 (my actual capital gain), and half of that will be included in my income as a taxable capital gain.
Under this rule, my sister’s cost of the property is ground down to $5,000. Assume she sells the property a few years later to a third party for $15,000. She will have a capital gain of $10,000, and half of that will be included in her income as a taxable capital gain.
So again, there is a potential for double taxation.
Gifts of property
For gifts, the rules are somewhat different. If you give a property, you have deemed proceeds equal to the fair market value of the property. But in this case, the recipient of the gift has a deemed cost equal to the fair market value, so that there is no double tax.
Example
I give a property to my sister when the fair market value of the property is $15,000. My cost of the property was $5,000.
Under this rule, I will have deemed proceeds of $15,000, leading to a capital gain of $10,000, and half of that will be included in my income as a taxable capital gain.
But my sister’s cost is bumped up to fair market value of $15,000. So let’s say she sells the property to a third party for $15,000. She will have no capital gain. There is no double taxation.
On a final note, for gifts, the recipient of the gift does not include the amount of the gift in income, whether it is cash or other property. For example, if I give my child a cash gift, or buy them a car or a house, they do not include anything in income.
Exception for transfers to spouse
If you transfer property to your spouse (or common-law partner), a different rule applies. It is a tax-free “rollover”, meaning that you have deemed proceeds equal to your cost of the property and your spouse picks up the same cost. So you have no capital gain or loss on the transfer.
If you wish, you can elect out of the rollover in your tax return for the year of the transfer. If you do so, the rules discussed above apply. In most cases, you will not want to elect out of the rollover. But in some cases it will make sense.
For example, let’s say you give a property to your spouse with an accrued capital gain. You have some capital losses that you could use to offset the gain. (Capital losses can only be used against capital gains.) So you elect out of the rollover, trigger the accrued capital gain, and use your capital losses to offset the gain, meaning you pay no tax on the transfer. The result for you is basically the same as under the rollover. But the difference, for your spouse, is that they get a bumped-up adjusted cost base equal to the property’s fair market value.
Example
I give a property to my spouse when the fair market value of the property is $15,000. My cost of the property was $5,000. I have $25,000 of capital losses that I have not yet claimed.
If I use the rollover, I will have proceeds of $5,000 and therefore no capital gain. My spouse will have a cost of $5,000 for tax purposes.
If I elect out of the rollover, I will have deemed proceeds of $15,000, leading to a capital gain of $10,000. But I can offset that gain with $10,000 of my unused capital losses. My spouse will then have a cost in the property of $15,000.
Unfortunately, you can not normally trigger a capital loss by electing out of the rollover. This is because of the “superficial loss” rule, discussed under the next heading.