From time to time clients discuss with me the issue of gifting assets to their children and/or their spouse. This act of generosity may result in a taxable situation if the asset has increased in value. The CRA will certainly thank you for your thoughtfulness in contributing money to their “piggy bank”! However, there are certain legal steps you can follow in order to spread the tax payable over a period of up to five years from the date of the gift — therefore keeping some of the tax monies in your “piggy bank” for a longer time period.
This method is accomplished by using the “Capital Gains Reserve” provided for in the Income Tax Act. The following is an actual situation a client of mine had to deal with (obviously, the names have been changed for privacy reasons). Sally Smith was the owner of a chalet which she wanted to gift to her four adult children with a value at the relevant time of $600,000.00. Sally had invoices indicating she upgraded the chalet in the form of an addition and improvements to the chalet of approximately $250,000.00. If Sally transferred the chalet to her children as a gift, she would have a taxable capital gain of $350,000.00 which would cost approximately $93,600.00 in taxes. Sally inquired if the end result would be different if she charged her children $1.00 for the chalet.
The bad news was that the transfer for $1.00 would not change the result; i.e. she would incur the same capital gains. However, if her children at some future date sold the property for $900,000.00, they would have $899,000.00 capital gain that would be taxable in their hands. This would result in a double taxation situation with Sally paying her capital gains tax and her children paying their capital gains tax. On the other hand, Sally can sell her chalet to her children for its market value of $600,000.00, her children can pay for it by way of a mortgage taken back which has a term that it is due “On Demand”; Sally can forgive the debt owing at the time of her death and no tax will actually have been paid on her death. However, Sally has to repay a minimum of 20 per cent of the capital gains tax annually commencing in the year of sale with the balance being spread over the next 4 years. As a result, Sally can pay her capital gains tax in five equal instalments rather than one lump sum payment of approximately $93,600.00. In my opinion, if you ever find yourself in a similar situation, I would recommend that you close the sale at the beginning of a calendar year in order that the first instalment can be paid on or before the end of the year; in other words, you can hold, use, or invest, the initial 20 per cent instalment for up to a year less a day from the Transfer Date. On the other hand, if the transaction takes effect September 1, 2018, you only have four months to hold, use, or invest the initial 20 per cent tax instalment.
