20 July 2000 External T.I. 1999-0013365 - expiry of a life interest

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues: 1) Is a capital loss created on the expiry of a life interest recognized on the death of the life interest holder if it is not denied by reason of 40(2)(g)(iii)? 2) Can the ACB of the remainder interest be increased by amounts paid by the estate for capital additions to the property or for the acquisition of the rights of the life interest holder?

Position: 1) yes 2) yes

Reasons: 1) Other than 40(2)(g)(iii), there is no statutory reason to deny a capital loss that arises on the deemed disposition of a life interest under 70(5) immediately before death; however the FMV of the life interest at that time, and thus the deemed proceeds of disposition under 70(5)(a), do not reflect the imminence of death for the reasons set out in the Mastronardi decision. 2) While there is no provision which would increase the ACB of the remainder interest upon the expiry of the life interest, amounts paid for capital improvements to the property or for the rights of the life interest holder are added to the ACB of the property subject to any adjustment required by 69(1)(a).

XXXXXXXXXX 		1999-001336
A. Humenuk
Attention:  XXXXXXXXXX 

July 20, 2000

Dear Sirs\Mesdames:

Re: Disposition of a Remainder Interest in Property Acquired by Will

This is in reply to your letter of March 15, 1999 concerning the tax consequences relating to the proposed disposition of a remainder interest in a vacation property where the life interest in the property is held by the surviving spouse. We acknowledge receipt of a copy of your letter to the tax services office of July 14, 1998 which presumes that the vacation property was held in a spousal trust. It is our understanding that the facts set out in your letter of March 15, 1999 more accurately reflect the actual situation with which you are concerned and that the property is not held in a spousal trust. We apologize for the delay in our response.

In the situation you describe, an individual gifted his spouse a life interest in vacation property upon his death and gifted the remainder interest to his estate to be held in trust until the death of the surviving spouse at which time, the property would be distributed among several capital beneficiaries. The property has increased in value, in part because of capital improvements made to the property by the estate. In order to simplify the administration of the estate, the executor wishes to dispose of the residual interest in the vacation property to one of the capital beneficiaries and distribute the proceeds among the capital beneficiaries. The surviving spouse will continue to hold the life interest in the property.

You ask how the fair market value of the vacation home on the death of the individual should be allocated between the life interest and the remainder interest for the purpose of determining the adjusted cost base of the estate's remainder interest in the vacation property and whether the amounts paid by the estate on account of capital improvements to the property can be added to the adjusted cost base of that interest.

You note that depending on the value of the life interest, the capital gain to be realized by the estate on the disposition of the remainder interest may be greater than it would have been if the entire property had been settled on the estate and ask for our comments on your analysis. Finally, you ask whether the adjusted cost base of the residual interest would be increased if the estate purchased the life interest from the surviving spouse for amount equal to the adjusted cost base of the surviving spouse's interest.

As explained in Information Circular 70-6R3, Advance Income Tax Rulings, it is not our practice to comment on a proposed transaction involving a specific taxpayer, except by way of an advance income tax ruling. Nevertheless, we offer the following general comments which may be of assistance to you.

All statutory references in this letter are references to the provisions of the Income Tax Act (the "Act").

When a life interest or a remainder interest in property is acquired by an individual as a consequence of a person's death, the adjusted cost base of that individual's interest in a property is determined under subsection 70(5) or (6) (as is applicable in the circumstances) at the time of the person's death. As indicated in paragraph 5 of IT-226R, Gift to a Charity of a Residual Interest in Real Property or an Equitable Interest in a Trust, the fair market value (the "FMV") of a life interest at a particular time will vary according to the type of gift, other interests in the property or trust and the documentation providing for the transfer. The general approach is to value the various interests taking into consideration the FMV of the property itself, the current interest rates, the life expectancy of any life tenants, and any other factors relevant to the specific case. The FMV of the residual interest is determined as the FMV of the property less the FMV of the life interest at that time. Although the comments in IT-226R are made in the context of valuing a gift made during the lifetime of the individual holding the property, the valuation principles would apply equally upon the creation of such interests as a result of the death of an individual. In the situation you describe, a valuation of the remainder interest in the vacation property would presumably have been required in order to properly determine the deemed proceeds of disposition of the vacation property for the deceased since subsection 70(6) would have applied to the portion of the property that was gifted to the surviving spouse.

The adjusted cost base of the estate's remainder interest in the property is determined under paragraph 70(5)(b) upon the death of the individual who created the remainder interest. In the case of Enstone v. The Queen (00 D.T.C 6144), the Federal Court of Appeal noted that there is no provision in the Act which precludes a claim for capital cost allowance on costs incurred by the owner of a life interest in an income earning property.

Similarly, there is no provision in the Act which precludes an addition to the adjusted cost base of a remainder interest in capital property in respect of capital improvements incurred by the holder of the remainder interest.

Any capital loss that arises as a result of the deemed disposition of the spouse's life interest in the vacation property immediately before her death under subsection 70(5) is deemed to be nil by reason of subparagraph 40(2)(g)(iii). As there is no provision in the Act by which an amount may be added to the adjusted cost base of the estate's remainder interest in the property upon the expiry of the life interest in the property, the capital gain to be realized by the estate on the ultimate disposition of the property after the death of the life interest holder will be higher than it would have been if the estate had received the whole property from the deceased and its deemed cost of acquiring the property under paragraph 70(5)(b) had been higher. However, depending on the circumstances, the principal residence exemption may be available to the estate in respect the property. See paragraph 35 of Interpretation Bulletin IT-120R5, Principal Residence, for further details.

While no amount is added to the adjusted cost base of the estate's remainder interest in the property as a result of the expiry of the life interest upon the death of the surviving spouse, an amount paid to the life interest holder for the purchase of those rights by the estate would form part of the estate's cost, and thus adjusted cost base, of the whole property. However, where the amount paid for the life interest is in excess of its fair market value at the time of its acquisition, paragraph 69(1)(a) may apply to restrict the cost of the acquisition to the fair market value of the life interest at that time.

As indicated in paragraph 22 of Information Circular 70-6R3 dated December 30, 1996, this opinion is not an advance income tax ruling and consequently, is not binding on the Canada Customs and Revenue Agency.

We trust our comments will be of assistance to you.

Yours truly,

T. Murphy
for Director
Resources, Partnerships and Trusts Division
Income Tax Rulings Directorate
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