Tax Implications of Adding Yourself on Title to Your Aging Parent’s Home: Principal Residence Considerations

Adding an adult child to the title of a parent’s home is often done for estate planning purposes, such as avoiding probate fees. However, this step brings important tax implications, particularly regarding the Principal Residence Exemption (PRE), potential capital gains tax, and the taxation of any deemed disposition upon death. This blog explores the risks involved for both the parent and the child, specifically focusing on whether the PRE might be affected, how the deemed disposition is taxed, and what happens when the child is in a higher tax bracket. We’ll also address whether the property ownership must be split 50/50 if both the parent and child are on the title but without a bare trust agreement.

Principal Residence Exemption and Title Changes

Under the Income Tax Act (ITA), a taxpayer’s principal residence is generally exempt from capital gains tax on sale, but this protection can be affected when adding someone else to the title. The PRE allows for only one principal residence designation per family unit per year (Section 54 of the ITA).

When a child is added to the title of a parent’s home, ownership may be split between the parent and child. This change could limit the PRE for either party, especially if the child owns another property and is already claiming the exemption on that property. Additionally, if the child is in a higher tax bracket, they could face a more significant tax liability when the property is ultimately sold or transferred, further complicating the family’s tax situation.

Bare Trust Arrangement

A common way to mitigate these risks is through a bare trust arrangement. In this scenario, while the child is added to the title, they do not gain beneficial ownership of the property. Instead, they hold the title for estate planning purposes, and the parent retains full beneficial ownership. This allows the parent to continue claiming the principal residence exemption on the entire property.

Without a bare trust arrangement, the CRA may assume the child has beneficial ownership, which could result in part of the capital gain being taxable in the child’s name when the home is sold or transferred, even if the child does not intend to use or live in the home.

Ownership Split: Must It Be 50/50?

A critical question that often arises is whether adding a child to the title automatically creates a 50/50 ownership split. In the absence of a bare trust arrangement or any other formal documentation, CRA typically assumes an equal ownership split between parties on title. However, the actual ownership percentage does not have to be 50/50. The key is how the ownership interest is documented and communicated to the CRA. For example, if only 10% of the property’s beneficial interest is transferred to the child, only 10% of any gain would be attributed to the child when the property is eventually sold or transferred.

If there is no clear documentation specifying the ownership percentages, both the child and the parent risk having CRA treat the ownership split as 50/50 by default. This could lead to unforeseen tax consequences, especially if the child is in a higher tax bracket or has already used their PRE for another property.

Deemed Disposition Upon Death: Who Pays the Tax?

When a parent passes away, a deemed disposition occurs under Section 70(5) of the ITA. This means the property is treated as if it were sold at its fair market value (FMV) at the time of the parent’s death, with any accrued capital gain subject to tax. The capital gain is calculated as the difference between the property’s FMV and its adjusted cost base (ACB). The tax liability for this gain can either be paid by the estate or, if ownership has been transferred, by the child.

1. With a Bare Trust: If the child is only on the title as a trustee and has no beneficial interest, the entire capital gain would typically be attributed to the parent. The estate would pay any taxes on the gain unless the parent’s estate can fully utilize the PRE, in which case no capital gains tax would apply.
2. Without a Bare Trust and 50/50 Ownership: If the child is a beneficial owner, even in part, they will be taxed on their portion of the capital gain. For instance, if the property is deemed to have increased by $500,000 in value and the child owns 50%, the child would be taxed on their share of the gain ($250,000). Since only 50% of a capital gain is taxable in Canada, $125,000 would be included in the child’s income. If the child is in a higher tax bracket, this could result in a substantial tax liability compared to what the estate would pay if it held the full ownership.

Example Calculation

Let’s explore two scenarios to illustrate the impact:

• Scenario 1: Bare Trust Arrangement
  • Parent’s home originally purchased for $300,000.
  • FMV at the time of death is $800,000.
  • Under a bare trust, the full capital gain ($500,000) is attributed to the parent, and since the home was the parent’s principal residence, the PRE can shield the entire gain. No capital gains tax would be payable by either the estate or the child.
• Scenario 2: No Bare Trust, 50/50 Ownership
  • Parent and child added to the title five years ago when the FMV was $600,000.
  • At the time of death, FMV is $800,000.
  • The child owns 50% of the home, with a capital gain of $100,000 on their portion ($400,000 FMV now vs. $300,000 when they were added to title).
  • The taxable portion of the gain is 50%, or $50,000, which will be included in the child’s income. If the child is in a high tax bracket (e.g., 45%), they would face a tax liability of $22,500. The estate would handle the tax on the remaining gain attributed to the parent.

Taxation of the Estate or the Child

In scenarios where the child has beneficial ownership, they will be responsible for paying taxes on any portion of the capital gain attributed to them. If the child is in a higher tax bracket, they could face a significantly higher tax burden than the estate would have, particularly if the estate can use lower tax brackets and available deductions.

If the child does not have beneficial ownership (i.e., under a bare trust arrangement), the estate bears the tax responsibility. However, if the parent qualifies for the full PRE, the estate can use the exemption to shelter the capital gain, resulting in no tax liability upon death.

Conclusion

Adding yourself to the title of your aging parent’s home can have significant tax implications, particularly if there is no clear bare trust arrangement in place. Without proper documentation, the CRA may assume a 50/50 ownership split, leading to potential tax liabilities for both the parent and the child. In the event of the parent’s death, the deemed disposition could result in a capital gains tax for the estate or the child, depending on the ownership structure.

For families where the child is in a higher tax bracket, it’s crucial to carefully consider how the property will be taxed and whether the estate or the child is better positioned to handle the tax consequences. Consulting with a tax professional can help ensure that the principal residence exemption is protected, and that your estate planning goals are achieved without unnecessary tax burdens.

For more information, visit Income Tax Folio S1-F3-C2: Principal Residence.

Sources:

• Income Tax Act (Canada), Section 54, Section 70(5)
• Income Tax Folio S1-F3-C2: Principal Residence

This information is for discussion purposes only and should not be considered professional advice. There is no guarantee or warrant of information on this site and it should be noted that rules and laws change regularly. You should consult a professional before considering implementing or taking any action based on information on this site. Call our team for a consultation before taking any action. ©2024 Shajani CPA.

Shajani CPA is a CPA Calgary, Edmonton and Red Deer firm and provides Accountant, Bookkeeping, Tax Advice and Tax Planning service.

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