How Real Estate Capital Gains Tax is Divided in a Divorce

Tax implications of transferring property to a spouse

When you transfer property to a spouse, there are generally no immediate tax implications. By default, the asset is transferred at its adjusted cost base (or the undepreciated capital cost for depreciable assets) without triggering a capital gain, unless you decide otherwise .

However, there may be subsequent tax implications due to the spousal attribution rules. Future income, such as dividends, interest, rental income or capital gains, may be allocated to the transferring spouse and taxed against them.

In the event of separation or divorce, Kay, the same tax-deferred rollover may apply if the transfer is made as part of a separation or divorce settlement. This applies to both de facto spouses and legally married spouses. The attribution rules also no longer apply after the breakdown of a relationship, so the beneficiary spouse is liable for future income tax.

This means in your case, Kay, that you and your ex-husband can transfer ownership of all three properties to each other as part of your divorce settlement without triggering capital gains tax. You mentioned that one of the three properties is in your name and that the other two are jointly owned. This tax-deferred transfer option would apply to all three properties, regardless of the name of the property and which of you receives the transfer.

Now that we have determined that there will be no immediate capital gains tax consequences, unless you decide otherwise, we need to determine what capital gains tax might apply to any of you or both in the future.

Can you avoid capital gains tax in a divorce?

The principal residence exemption allows a couple to declare a qualifying property as their principal residence tax-free for a given tax year. A qualifying property is one that a couple usually inhabits. This could be a cottage, vacation property, or other property that may not be their primary residence or primary place of residence.

You and your ex-husband, Kay, own a house and two investment condos. Assuming both investment condominiums have been rental properties, there is deferred tax on capital gains to the extent that their value has appreciated. You and your ex-husband may only be able to claim the principal residence exemption for your home, assuming you haven’t done so for any other property you both previously owned during the years you owned your marital home.

If your husband moves into one of the investment condos, this act alone will not be enough to negate the deferred capital gains tax. Moving into an investment property and selling it does not qualify you for the principal residence exemption and avoid historical capital gains tax. In fact, moving into it may result in the imposition of capital gains tax since the property is subject to a change in use from income producing to personal use. This results in a deemed disposition or notional sale of the property at fair market value.

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