What's CRA's Position on Family Gifts?
Large gifts of money and property will get CRA's attention. Follow these tips to limit the tax burden for giver and receiver.
Gifts of property among family members are common and can be very welcome for the recipient and satisfying for the giver. Although Canada has no gift tax, in some cases a gift can trigger tax rules that could increase your income taxes and prevent a win-win situation for both you and the recipient.
These tax rules are in place to ensure that, first, taxpayers do not abuse income splitting strategies and, second, that CRA receives all income taxes to which is it rightfully entitled.
Income splitting strategies are designed to shift taxable income from individuals in high tax brackets to family members in lower tax brackets. The Income Tax Act, however, contains several income attribution rules that, in many cases, will override the income splitting efforts of taxpayers by extracting tax that otherwise was payable.
Attribution rules apply to several situations, including:
- Income and losses from property transferred to a spouse or minor family member
- Capital gains/losses realized on property transferred to a spouse
- Transfers of property to a trust.
Note that in tax terms "transfer" has a broad definition that covers just about any way ownership of a property is moved from one person to another. A transfer includes both a gift and a sale.
Election to Avoid Attribution Rules
Property transferred at fair market value (FMV) is not subject to attribution rules. If you want to transfer property to your spouse as a gift and still avoid attribution rules you must elect that spousal rollover rules do not apply. In that case, you then will report any accrued gains on the property and your spouse will report any future gains.
Should you sell or transfer property to a family member for less than fair market value (so you give them a cut rate but not an outright gift), not only could attribution rules apply, but CRA will adjust your "deemed proceeds" from the transaction upward to the property's FMV. This triggers any accrued gains, which will be taxable. And your relative will also be deemed to have received property equal to whatever he or she paid for it, not its FMV.
Avoid Double Tax With a Gift
In such a case, the family as a whole might end up paying double tax on a portion of any accrued capital gains. That's because the recipient will also be taxed again on that portion of the gains between his or her actual cost and the FMV at the time of transfer which you will have already reported.
However, if you make an outright gift of the property to your family member, the family member's cost is "bumped" up to the FMV, thereby avoiding this double-tax issue.
On the other hand, there also is a downside to giving property to a family member for a stated value that is higher than its FMV, as the family member's deemed cost will be adjusted downward to the FMV. Your proceeds of disposition for the property would still equal the actual selling price you had set on the property at the time of the transfer.
Making the gift or transfer of property to your spouse, as opposed to a child or other family member, usually will automatically occur on a tax-free basis, unless you elect otherwise. However, you and your spouse must both be Canadian residents at the time of the transfer.
If you transfer property to your spouse or a family member who is under 18 years of age, any income earned from that property is attributed to you, the transferor.
Similarly, any loss from the property also becomes your loss. However, this rule does not apply to a transfer of property for use in a business of a spouse or minor.
Income from the property could be in various forms, including interest, dividends, rents and royalties. A loss from the property could arise in a situation where the expenses incurred to earn income from the property exceed the income earned.
Expenses incurred for the purpose of earning interest and dividend income could include interest paid on borrowed money, investment counsel fees, and other carrying charges.
If you transfer the property to your spouse, any capital gains or allowable capital losses on subsequent disposal of that property also attribute to you.
However, if you give the property to a minor family member, such as a child, grandchild, niece or nephew, the capital gains or losses do not attribute to you. Therefore, if you have assets you expect to increase substantially in value, such as shares in a corporation, jewellery or art, consider transferring them to your children or a trust for your children.
While any dividends will be attributed to you until your children reach 18, capital gains on the sale of the assets will not be.
Good Ways to Give
While the attribution rules may sound restrictive, there are some additional ways you can make gifts to your family members that will create some tax benefits for you.
For example, you could make a gift of your home and if it was your principal residence for each year you owned it, the transfer will be tax-exempt. To qualify as a principal residence you, your spouse or child must have ordinarily inhabited it.
You also could transfer a non-principal residence, such as a cottage or a rental dwelling, to an adult child and it could qualify as the child's principal residence if the child occupied it. You would be liable for any accrued gain up to the time of transfer, but assuming the home remained your child's principal residence, there would be no further taxable gain for the child.
You also could consider making the following types of gifts to family members that will avoid attribution rules:
- Use your own funds to pay your spouse's tax bills throughout the year. Since the payment goes straight to CRA and is not invested by your spouse, there is no property from which income can be attributed. That means that any funds your spouse would have used to pay the income taxes can be invested without the income being attributed to you.
- Pay the interest on your spouse's investment loans. There will be no attribution so long as you do not pay any principal on account of the spousal loan. The interest will be deductible on your spouse's tax return.
- Make contributions to your spouse's RRSP. Income earned in the RRSP is tax-sheltered and when the funds are turned into an annuity or RRIF the payments are income to your spouse.
- Make gifts to your adult children (18 or over) to enable them to earn sufficient income to absorb their deductions and credits and also to pay for certain expenses that you would ordinarily pay out of after-tax dollars.
- Give your adult children enough funds to allow them to make the maximum deductible contributions to their RRSPs.
- Deposit Canada Child Tax Benefits or Universal Child Care Benefits into your child's bank account or a Registered Education Savings Plan (RESP) because attribution will not apply to income earned on these funds.
It's great to give and receive gifts, just be sure you do it correctly to avoid the gift becoming a tax burden. Make sure you consult with your accountant or tax professional ahead of time or you might end up with an unexpected tax bill.
Read the following Knowledge Centre articles for more information on family gifts as well as charitable gifts: