Every parent wants to give their children the best of everything. It is normal for a couple to transfer their home to their child to save the child from the probate fees. There are two aspects: First, the property is a primary residence as the couple resides there; Second, the transfer of ownership to the child. In Canada, the sale of a principal residence is exempt from capital gains tax, and only the owner of the house selling it can avail of this benefit. However, the transfer of property from parent to child is considered as a deemed disposition at the fair market value (FMV), and the child has to pay capital gains tax.
So, how does the principal residence exemption work when transferring property to the child?
The Income Tax Act (ITA) allows only one principal residence designation per family unit year. Here, you can have two scenarios.
- You own the property and add your child as a beneficiary owner.
- You own the property and transfer the title to the child.
Like this, there can be multiple scenarios, each with a different tax solution.
Taxation of Principal Residence When Transferring Home to Child
Parent: You are the homeowner, and the property qualifies for the principal residence exemption (PRE). To be eligible for PRE, you and your family should live in that house and must not have rented it to earn income. However, renting the house for a few weeks as you are going out on vacation won’t affect PRE qualification as you are still the primary occupant.
When you transfer full ownership of the house to your child, it will be deemed the sale of the primary residence at fair market value (FMV), and you can claim the PRE.
Child: While the child may not pay anything to the parents, he/she will have to pay capital gain tax on the difference between the FMV and the cost of the property. The tax calculation is not that simple.
Tax Impact on Adding Child as Beneficiary Owner
If you make your child a beneficiary owner, there will be two owners of the property, and the parents cannot avail themselves of the full PRE. Let’s understand this with an illustration.
Scenario 1:
Jacob purchased the house for $250,000 in 2000 and added his son Jim as a beneficiary owner in 2010 when the FMV was $350,000. Since no specification is mentioned, the Canada Revenue Agency (CRA) will consider Jim a 50% owner.
Jacob passed away in 2020 when the property’s FMV was $600,000. Jim is now the sole owner of the property. Jacob’s 50% ownership will get the PRE, but Jim has to declare capital gain on his 50% ownership and pay tax even if he does not stay in that property.
Jim was added to the title in 2010 when the property’s FMV was $350,000. Since then, the property has appreciated by $250,000. As Jim is a 50% owner, he will pay a capital gain tax on his appreciation portion, which is $125,000.
The way capital gain tax works, 50% of the capital gain up to $250,000 is added to the taxable income. Jim will add $62,500 (50% of his portion of the $125,000 capital gain) to his personal income tax. If Jim falls under the high-tax bracket of 45%, he will pay a tax bill of $28,125.
Tax Solution to Retain Principal Residence Exemption
Bare Trust: As Jacob divided the ownership, he could not claim full PRE on the deemed sale of his residence. Instead of giving your child direct ownership, you can create a bare trust agreement, where the child is the trustee and has no beneficial interest in the home. Since the entire ownership is with the parent, they will be entitled to the entire capital gain and can claim full PRE, which means no capital gains tax would apply.
Scenario 2:
Mary and John have a condo and purchased an apartment for their child, Susan. Susan has been living in the apartment all the while. Now, the parents want to transfer the ownership to Susan. The property title is with Mary and John, and a family member ordinarily inhabited the apartment so that they could qualify for a full PRE.
However, the parents can only have one principal residence in a year. Suppose the parents lived in the condo for 20 years and bought the apartment 10 years ago. If they transfer the apartment to Susan and claim PRE, they will wipe 10 years of PRE from their condo. If Mary and John want to sell their condo, they must pay capital gain tax on those 10 years they used for the apartment.
In such scenarios, using the PRE on the property with a higher capital appreciation is advised. For parents who want to buy a home for their children, it is better to buy the house under the child’s name to avoid transfer of ownership.
Contact Black and Gill LLP in Toronto to Help You with Property Transfers and Estate Planning
Whatever the situation, it is always better to talk to a tax advisor who can guide you on other ways to save taxes, depending on your situation. Knowing your tax implications can help you arrange the funds needed for the liability. At Black and Gill LLP, our accountants and tax consultants can provide services such as tax planning for property and other estate. To learn more about how Black and Gill LLP can provide you with the best tax planning expertise, contact us online or call us at 416-477-7681.