26 March 2007 External T.I. 2006-0216421E5 - Transfer of Life Interest - Farm Property

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: What are the tax consequences of an intergenerational transfer of a life interest in farm property?

Position: General comments. It is possible that a gain could be deferred.

Reasons: Subsection 73(3) of the Act.

								2006-021642
XXXXXXXXXX 							James Atkinson CGA
(519) 457-4832
March 26, 2007

Dear XXXXXXXXXX:

Re: Capital Gains - Transfer of Life Interest - Farm Property

This is in response to your undated letter inquiring about potential capital gains resulting from an intergenerational transfer of a "life interest" or "life estate" (hereinafter referred to as a "life interest") in farm property. We apologize for the delay in responding.

You describe a situation, which we understand to be as follows:

A father (Mr. A) operated a farm and owned farmland. Mr. A died in 1993. Under the terms of his will, his spouse (Mrs. A) was bequeathed a life interest in the farm property. The life interest allows Mrs. A the use, occupation and enjoyment of the farm property until her death at which time the farm property is to be transferred to Mr. and Mrs. A's son. Mr. A's son acquired a "residual interest" or "remainder interest" (hereinafter referred to as a "residual interest") in the farm property at the time of Mr. A's death by operation of Mr. A's will.

At this time, Mrs. A has moved from the farm property to a retirement home and is contemplating the transfer of her life interest in the farm property to her son currently, prior to her death.

You question whether capital gains may arise as a consequence of a transfer of Mrs. A's life interest in the farm property to her son.

Our Comments:

The situation outlined in your letter appears to relate to a factual one, involving a specific taxpayer. It is not this Directorate's practice to comment on proposed transactions involving specific taxpayers other than in the form of an advanced income tax ruling. For more information about how to obtain a ruling, please refer to Information Circular 70-6R5, Advanced Income Tax Rulings, dated May 17, 2002. This Information Circular and other CRA publications can be accessed on the internet at http://www.cra-arc.gc.ca. Although we cannot comment on your specific situation, we are prepared to provide the following general comments, which may be of assistance.

Pursuant to subsection 70(5) of the Income Tax Act (Act), a deceased taxpayer is deemed to have disposed, immediately before his or her death, of each capital property owned by the taxpayer for proceeds of disposition equal to the fair market value (FMV) of the property immediately before death. Accordingly, the deceased is generally taxed on any capital gain that accrued to the date of death.

However, subsection 70(5) of the Act does not generally apply in respect of any capital property of the deceased taxpayer that is, as a consequence of the death, transferred or distributed, within a period of 36 months after the death or within such longer period as considered reasonable in the circumstances, to the taxpayer's spouse or common-law partner who was resident in Canada immediately before the taxpayer's death, unless an election is made under subsection 70(6.2) of the Act to have subsection 70(5) apply. Where no election is made, pursuant to subsection 70(6) of the Act, such transfers or distributions are generally deemed to be made for proceeds of disposition equal to the property's adjusted cost base (ACB) to the taxpayer immediately before death. Accordingly, any capital gain that accrued prior to the date of death will be taxed in the hands of the transferee when he or she subsequently disposes of the property.

When a life interest in real property is acquired by a spouse as a consequence of a person's death, the cost of that spouse's interest in the property is determined under subsection 70(5) or (6) (as is applicable in the circumstances depending on whether or not the above-mentioned election was filed) at the time of the person's death. If an election is filed, paragraph 70(5)(b) of the Act would apply and the spouse would acquire the life interest in the farm property at a cost equal to its FMV immediately before the person's death. If the subsection 70(6.2) election is not made, subsection 70(6) would apply deeming the spouse to have acquired the interest on a rollover basis. For this purpose, the ACB would be equal to a proportionate share of the deceased's ACB of the entire property. The subject of transfers of farm property on death is discussed in more details in Interpretation Bulletin IT-349R3, Intergenerational Transfers of Farm Property on Death.

Any transfer or gifting of Mrs. A's life interest in the farm property to her son constitutes a disposition and except as expressly provided for by the Act, when anything is disposed of by a taxpayer to a person with whom the taxpayer does not deal at arm's length for no proceeds or for proceeds less than its fair market value, under paragraph 69(1)(b) of the Act, the taxpayer is deemed to have received proceeds of disposition equal to its fair market value. An exception to this rule is provided for under subsection 73(3) of the Act, which essentially provides for the deferral of the tax consequences on the transfer of farm property that is land, depreciable property of a prescribed class or eligible capital property from a parent to a child. To be eligible for that provision to apply, the property must have been used, before the transfer, principally in the business of farming in Canada in which the taxpayer (transferor), the taxpayer's spouse (or common-law partner) or any of the taxpayer's children, was actively engaged on a regular and continuous basis.

The determination of whether real property is used principally in carrying on a farming business is a question of fact. Where reference is made to an asset being used principally in the business of farming, the asset will meet this requirement if more than 50% of the asset's use is in the business of farming. In our view, when determining whether assets will meet the more than 50% requirement, the test has to be applied on a property-by-property basis. Subsection 73(3) states, in part, that "... the property was, before the transfer, used principally in the business of farming...". There is no requirement that the property be used immediately before the transfer in the business of farming. However, as indicated in paragraph 24 of IT-268R4, Inter Vivos Transfer of Farm Property to Child, if the property is used for some purpose other than farming for some period of time, a question may arise as to whether the property was used principally for that other purpose rather than in the business of farming.

Based on the information provided, it is unclear whether or not an election was ever made under subsection 70(6.2) and whether or not the above-mentioned conditions of subsection 73(3) are met. Therefore, we are unable to express an opinion as to whether the rollover provisions of subsection 73(3) would be applicable to Mrs. A's transfer to her son of her life interest in the real property. However, as the life interest in these circumstances appears to relate to both farmland and Mrs. A's principal residence, a reasonable allocation would have to be made to determine the extent of any capital gain or loss that may arise from the transfer and may be attributable strictly to the farmland or to the residence. Any portion of that loss attributable to personal-use property (Mrs. A's principal residence) would be denied as a consequence of subparagraph 40(2)(g)(iii) of the Act which denies a capital loss on the disposition of any personal-use property. To the extent a capital gain is in respect of the principal residence, it may be eligible for the principal residence exemption, as explained in Interpretation Bulletin IT-120R6, Principal Residence.

In view of the complexity of the subject matter and the uncertainties regarding the facts, you may wish to consider obtaining professional advice.

We trust that these comments will be of assistance.

Yours truly,

S. Parnanzone
For Director
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch