15 June 2022 STEP Roundtable Q. 9, 2022-0929391C6 - Section 43.1 - Life Estate

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: 1. Does subsection 43.1(1) apply when a parent disposes of a remainder interest in real property to a trust under which the parent's child is the beneficiary and the parent retains a life estate in the property? 2. What happens if the parent gifts the life estate in the property to the trust prior to their death? 3. What happens if the life estate held by the parent is terminated by his or her death?

Position: 1. Yes. 2. Paragraph 69(1)(b) and (c) will apply. 3. Paragraph 43.1(2)(a) and (b) apply to the termination.

Reasons: 1. Where a remainder interest in real property is disposed of to a trust by a parent who retains a life estate in the property, paragraph 43.1(1)(a) and (b) will apply to the disposition. Since the child of the parent is the beneficiary under the trust, pursuant to paragraph 251(1)(b), the parent and the trust are deemed not to deal with each other at arm's length. Accordingly, subparagraph 69(1)(b)(i) will apply to the disposition of the remainder interest if the parent receives no POD or POD less than FMV. If the remainder interest is disposed of by way of gift, subparagraph 69(1)(b)(ii) and paragraph 69(1)(c) will apply. 2. If parent disposes of the life estate to the Trust for no proceeds or for proceeds less than FMV, subparagraph 69(1)(b)(i) will apply to the disposition. If the parent disposes of the life estate by way of inter vivos gift to the trust, subparagraph 69(1)(b)(ii) and paragraph 69(1)(c) will apply to the disposition.

3. If the parent passes away prior to the sale of the property and the life estate to which subsection 43.1(1) applied is terminated, paragraph 43.1(2)(a) applies to the termination. Since the parent does not deal with the trust at arm's length, the ACB of the property held by the trust would be increased in accordance with paragraph 43.1(2)(b).

2022 STEP CRA Roundtable – June 15, 2022

Question 9. Section 43.1 – Life Estate

If a taxpayer transfers a remainder interest in real property to another person and retains a life estate in the property, subsection 43.1(1) of the Act (footnote 1) will apply to the disposition as long as all conditions therein are satisfied. If, upon the death of an individual, the life estate to which subsection 43.1(1) applied is terminated:

• the holder of the life estate immediately before the death is, generally speaking, deemed pursuant to paragraph 43.1(2)(a) to have disposed of the life estate for proceeds of disposition (“POD”) equal to the holder’s adjusted cost base (“ACB”); and
• the ACB of the property to the holder of the remainder interest is increased pursuant to paragraph 43.1(2)(b), if the individual who held the life estate was not dealing at arm’s length with the holder of the remainder interest in the real property.

Questions

a) What provisions of the Act apply if, rather than transferring a remainder interest in a principal residence (the “Residence”) directly to an adult child (the “Child”), a parent (“Parent”) transfers the remainder interest to a personal trust under which the Child is a beneficiary?

b) If Parent later moves out of the Residence to live in an assisted-living residence and the Residence is sold prior to the death of Parent what provisions of the Act then apply? Does the ACB of the life estate stay with Parent, with no adjustment available to the trust? Alternatively, is the life estate considered to be a gift from Parent to the trust at the time of Parent’s relocation, thereby resulting in an increase in the ACB of the remainder interest to the trust?

Consider the following example:

• Parent transfers a remainder interest in the Residence to a personal, inter vivos trust (the “Trust”) and retains a life estate in the property;
• The Child is the only beneficiary under the Trust;
• At the time of the transfer of the remainder interest:
  • the Residence has a fair market value (“FMV”) of $250,000;
  • the life estate has a FMV of $50,000; and
  • the remainder interest has a FMV of $200,000;
• Assume all conditions in the definition of “principal residence” contained in subsection 54(1) are satisfied and that Parent has never claimed the principal residence exemption on any other property;
• Parent later moves out of the Residence and willingly disposes of the life estate to the Trust to enable the sale of the Residence to a third party;
• The Residence is immediately sold to an arm’s length third party; and
• At the time of the sale, the Residence has a FMV of $400,000.

c) Does the answer change if Parent continues to live in the Residence while the remainder interest is held by the Trust and the Residence is not sold until after Parent’s death? Is the trust considered not to deal at arm’s length with Parent such that paragraph 43.1(2)(b) will apply?

CRA Response

Part a)

Pursuant to paragraph (c) of the definition of “disposition” in subsection 248(1), a disposition includes any transfer of property (footnote 2) to a trust, other than a transfer described in paragraph (f) or (k). Therefore, when Parent transfers the remainder interest in the Residence to the Trust a disposition of property occurs.

Notwithstanding any other provision of the Act, subsection 43.1(1) applies any time a taxpayer disposes of a remainder interest in real property (except as a result of a transaction to which subsection 73(3) would otherwise apply or by way of a gift to a qualified donee) to another person and the taxpayer retains a life estate in the property. When subsection 43.1(1) applies, the taxpayer who disposes of the remainder interest in the real property is deemed:

• under paragraph 43.1(1)(a): to have disposed of the life estate in the property for POD equal to its FMV at that time; and
• under paragraph 43.1(1)(b): to have reacquired the life estate immediately after that time for a cost equal to the above POD.

Therefore, when Parent disposes of the remainder interest in the Residence to the Trust and retains a life estate, Parent will be deemed to have disposed of the life estate for POD equal to $50,000 and to have reacquired the life estate at a cost of $50,000.

Pursuant to paragraph 251(1)(a), Parent is deemed not to deal with the Child at arm’s length. Accordingly, Parent and the Trust are deemed pursuant to paragraph 251(1)(b) not to deal with each other at arm’s length because the Child is beneficially interested in the Trust.

Where a taxpayer has disposed of anything to a person with whom the taxpayer was not dealing at arm’s length for no proceeds or for proceeds less than FMV, or to any person by way of gift, paragraph 69(1)(b) will apply to the disposition. Whether a property is disposed of for no proceeds or by way of gift is a question of fact and law.

If, based on all the facts and surrounding circumstances, it is concluded that Parent has disposed of the remainder interest to the Trust for no proceeds or for proceeds less than FMV, subparagraph 69(1)(b)(i) will apply to the disposition. Parent will be deemed to have received POD equal to the FMV of the remainder interest at the time of its disposition to the Trust, which in the above example is $200,000.

Alternatively, if it is concluded that Parent has disposed of the remainder interest to the Trust by way of gift, subparagraph 69(1)(b)(ii) will apply and will yield the same result as subparagraph 69(1)(b)(i) for Parent as they will be deemed to have received POD equal to $200,000. Additionally, since the Trust has received the remainder interest by way of gift, the Trust will be deemed under paragraph 69(1)(c) to have acquired the remainder interest at a cost equal to its FMV, which is $200,000.

In the case of a principal residence as defined by section 54, provided the conditions therein are satisfied, any capital gain realized by Parent on the deemed disposition of the life estate and on the disposition of the remainder interest to the Trust would be sheltered by the principal residence exemption.

Part b)

Subsection 43.1(2) will only apply to the termination of a life estate if subsection 43.1(1) applied to the life estate and said termination is caused by the death of an individual. In this case, Parent moves out of the Residence and the Residence is immediately sold by the Trust.

If Parent has disposed of the life estate to the Trust for no proceeds or for proceeds less than FMV, subparagraph 69(1)(b)(i) will apply to the disposition and will deem Parent to have received POD equal to the FMV of the life estate at the time of its disposition to the Trust. If the life estate was disposed of to the Trust by way of an inter vivos gift, subparagraph 69(1)(b)(ii) would apply to deem Parent to have received POD equal to the FMV of the life estate and paragraph 69(1)(c) would deem the Trust to have acquired the life estate at a cost equal to that FMV.

Where the FMV of the life estate has increased from the time of the deemed disposition to which subsection 43.1(1) applied, Parent may realize a further gain on the disposition thereof. Alternatively, where the FMV of the life estate has decreased and Parent incurs a loss on the subsequent disposition of their life estate, the loss would be denied by subparagraph 40(2)(g)(iii) since the loss is from the disposition of personal-use property as defined in section 54 (footnote 3) .

Part c)

When a life estate to which subsection 43.1(1) applied is terminated by the death of an individual, paragraph 43.1(2)(a) will apply. Pursuant to paragraph 43.1(2)(a), Parent will be deemed to have disposed of the life estate immediately before their death for POD equal to their ACB of the life estate immediately before the death.

As explained above, Parent and the Trust are deemed under paragraph 251(1)(b) not to deal with each other at arm’s length. Therefore, paragraph 43.1(2)(b) will also apply to the termination of the life estate. As such, an amount will be added to the ACB of the Residence equal to the lesser of:

• the ACB of the life estate in the property immediately before the death; and
• the amount, if any, by which the FMV of the property immediately after the death exceeds the ACB to the Trust of the remainder interest immediately before the death.

To determine whether a trust can claim the personal residence exemption, refer to paragraphs 2.65 to 2.68 of Income Tax Folio S1-F3-C2, Principal Residence.

Dawn Dannehl
2022-092939

FOOTNOTES

Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:

1 The Act means the Income Tax Act R.S.C. 1985 (5th Supp.) c.1 as amended from time to time and consolidated to the date of this response and, unless otherwise expressly stated, every statutory reference herein is a reference to the relevant provision of the Act.

2 Pursuant to paragraph (a) of the definition of “property” in subsection 248(1), property includes a right of any kind whatever, a share or a chose in action.

3 According to the definition contained in section 54, personal-use property includes property owned by the taxpayer that is used primarily for the personal use or enjoyment of the taxpayer or for the personal use or enjoyment of one or more individuals each of whom is: the taxpayer, a person related to the taxpayer or where the taxpayer is a trust, a beneficiary under the trust or any person related to the beneficiary.