Federal Budget 2024 announced an increase of the capital gains inclusion rate from one-half to two-thirds on capital gains realized on or after June 25, 2024. The first $250,000 of capital gains realized per year by an individual would remain subject to the 50% inclusion rate. With the proposed increase, among other potential planning opportunities, taxpayers may wish to consider gifting to the next generation or a family trust appreciating personal use property such as secondary residences (cottages), artwork, and jewellery that have an accrued gain and/or may appreciate significantly in the future.
Gifting capital property will generally result in the transferor being deemed to have received fair market value proceeds on the disposition of the gifted property (the recipients in turn will be deemed to have acquired the property for the same value). Accordingly, capital gains would generally be realized in the year of transfer where the fair market value exceeds the adjusted cost base of the capital property.
Where the gifted property is real estate, land transfer tax should be considered. However, if the transferee is not assuming a mortgage with respect to the property, a gift of land generally does not result in land transfer tax as the tax is calculated on the value of the consideration.
Some benefits of transferring capital properties by way of gift include:
- Lower inclusion rate on accrued gains: if the transfer occurs prior to June 25, 2024, the lower 50% inclusion rate would be applicable to any realized capital gains.
- Tax deferral on future gains: Tax on future appreciation on capital properties can be deferred until the death of the younger generation (similar to the deferral benefit created by an estate freeze).
Transferring to a family trust can further extend the deferral benefit where the capital property is rolled out on a tax-deferred basis in advance of the trust's 21-year deemed disposition date to an even younger generation (i.e., grandchildren). If the property is disposed by the trust, then the capital gains on the disposition can be allocated among the beneficiaries, potentially saving taxes based on marginal tax rates (among other things). Subject to concerns with the application of s. 75(2) of the Income Tax Act that can attribute income and capital gains from the property back to the giftor, the giftor can retain some control over the property after it is transferred to the trust (e.g., by the terms of the trust providing the giftor with a life-interest in the trust, and/or having the giftor as one of the trustees).
Some drawbacks of transferring capital properties by way of a gift include:
- Paying taxes now: Gifting capital property can result in taxes arising in the current year (payable by April 30, 2025). Taxes on a disposition of the property may have otherwise been realized on the passing of the giftor (or the giftor's spouse).
- Application of the alternative minimum tax (AMT): Although the capital gains inclusion rate is 50% prior to June 25, the capital gains inclusion rate for AMT purposes is 100% as of January 1, 2024. AMT may be applicable (and results in higher taxes) where individuals gift capital property in 2024. AMT can be carried forward for seven years to offset ordinary income tax in those years to the extent that ordinary income tax exceeds AMT.
- Loss of use of capital gains reserve: A gift of capital property will preclude the use of the capital gains reserve that can spread a capital gain on the disposition of the property across (up to) five years. To utilize the capital gain reserve, consideration could be given to selling the property to the next generation for a promissory note. However, in the case of real estate, land transfer tax would apply. The giftor can later consider forgiving payment obligations or gifting funds to repay the note.
Although June 25 is quickly approaching, the impact of the decision to transfer or not transfer capital properties before the capital gains inclusion rate increase can be long-lasting. Taxpayers should carefully weigh the pros and cons of triggering capital gains in their particular circumstances.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.