My spouse and I separated in September 2020. I hold sole title to our matrimonial home, and we jointly own two investment condos. He currently lives in one of the condos (Condo A) but plans to move into Condo B and use the equity from Condo A to buy me out. After that, we would sell Condo A. I’m concerned he might be structuring this to avoid paying capital gains tax. What steps can I take to minimize my own capital gains tax liability under the rules?
– Kay
Tax consequences of transferring property between spouses
When one spouse transfers property to the other, the transaction usually does not create an immediate tax liability. By default, the transfer occurs at the property’s adjusted cost base (ACB) — or for depreciable assets, the undepreciated capital cost — without triggering a capital gain. This tax-deferred rollover applies unless the spouses choose a different tax treatment.
That said, spousal attribution rules can affect tax outcomes prior to a relationship breakdown. These rules can attribute future income produced by the transferred asset — such as interest, dividends, rental income or capital gains — back to the transferring spouse, who would then be taxed on that income.
Once a relationship ends, however, transfers made as part of a separation or divorce settlement generally qualify for the same tax-deferred rollover between spouses. That applies to both legally married and common-law partners. Importantly, after the relationship breakdown, the attribution rules no longer apply and the receiving spouse is responsible for tax on any future income or gains from the asset.
Applied to your situation, Kay, this means you and your ex-husband can reassign ownership of the three properties as part of your separation settlement without immediately triggering capital gains tax — regardless of whether a property is titled in one name or jointly. Transfers executed under the divorce or separation rollover will be treated at the transferring spouse’s cost base unless you elect otherwise.
With that immediate tax deferral in mind, the key issue becomes which capital gains tax liabilities may arise later when properties are sold or change use.
Can capital gains be avoided through a divorce-related property transfer?
Canada’s principal residence exemption can shelter the sale of a qualifying home from capital gains tax for the years it is designated as a principal residence. Eligible properties are those ordinarily used as a home by the claimant, and that can include cottages or certain vacation properties if they meet the residency conditions.
In your case, you and your ex‑husband own a matrimonial home plus two investment condos. If those condos have been rented and produced rental income, any appreciation to date represents accrued capital gains that remain deferred until a triggering event — such as a disposition or an eligible deemed disposition — occurs.
The ability to claim the principal residence exemption will typically be limited to the matrimonial home, assuming neither of you previously designated another property as your principal residence for overlapping years. Simply moving into an income-producing condo does not automatically convert prior appreciation into principal-residence-exempt gains. In fact, converting a rental property to personal use often creates a deemed disposition at fair market value — potentially crystallizing a tax liability unless special elections apply.
Your ex-husband might try to defer taxation on the condo he moves into by using a subsection 45(3) election, which can delay recognizing the gain that accrued before the change in use. To be eligible for that election, certain conditions must be met, including that capital cost allowance (depreciation) has not been claimed on the property. The election must be filed within the required timeframe (generally within 90 days after CRA requests it or by the taxpayer’s return-filing deadline for the year of sale, as applicable).
Even if an election defers future appreciation, any gain that has already accrued up to the date of the separation or the date of the change in use remains a relevant consideration for settlement negotiations.
How capital gains and tax liabilities are handled during property division
During a separation or divorce, spouses typically identify and value all assets and liabilities and determine how to divide them. That valuation should explicitly account for any deferred tax liabilities, including accrued capital gains on investment properties and other tax-deferred assets.
There are several approaches to addressing the tax consequences of the condos you own jointly. You and your ex-husband can agree to split the eventual capital gains tax on the investment properties, or he can assume the properties on a tax-deferred basis in exchange for a higher share of other assets. Settlement discussions and equalization calculations commonly adjust asset allocations to reflect deferred tax burdens.
Key points for you to consider as you negotiate or plan:
- You and your ex-husband can typically claim the principal residence exemption for your matrimonial home for the years it qualifies, which would shelter its sale from capital gains tax, provided you have not designated another property for the same years.
- The investment condos can be transferred between spouses on a tax-deferred rollover as part of the separation settlement, preserving their existing cost bases.
- If your husband moves into one of the investment condos and later sells it, there are mechanisms to defer some tax consequences, but any accrued gains to date generally remain relevant and may be taxable unless properly addressed by an election or other relief.
- Converting an income property into a principal residence only protects appreciation from the time the property becomes a principal residence; it does not automatically eliminate tax on past appreciation and may itself trigger a deemed disposition unless an election applies.
- Deferred taxes and future capital gains are normally part of the overall equalization calculation in a separation or divorce; your family lawyer and tax advisor should ensure these amounts are reflected fairly in the settlement.
As you proceed, Kay, consult both a family lawyer and a tax professional. They can help you value the properties, determine the tax consequences of proposed transfers, and structure the settlement so it fairly reflects any deferred taxes or future liabilities. That way you can protect your financial position and avoid unintended tax exposure.
Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto. He does not sell financial products.
Read more from Jason Heath:
- Do you pay capital gains tax when separating or divorcing?
- The tax implications of transferring a stock between spouses
- Buying a home after divorce
- Capital gains when selling property to family