When you split up with your spouse you will need to divide your assets evenly. The division of assets upon relationship breakdown is a provincial/territorial concern and there are variations across the country depending on where you live. There are also differences depending on the nature of your relationship (married, common law, same sex). Consequently, you are advised to consult with a lawyer familiar with the laws of your province or territory.
However, the laws across Canada do have some factors in common. Generally the law regards a marriage as a partnership and although, in many provinces, assets brought into a marriage are not usually subject to division, the increase in those assets can be divided upon a separation. In most cases, you'll be able to transfer assets between the two of you without a tax hit. Capital property (most assets) can transfer at adjusted cost base (ACB) so that the recipient spouse inherits the current ACB of the property, and there's no tax to pay on the transfer. Registered Retirement Savings Plan (RRSP) assets can transfer directly to the other spouse's RRSP without a tax hit. It's the same with assets in a Tax-Free Savings Account (TFSA). In the case of a TFSA, the transferor doesn't receive a reinstatement of contribution room.
Any family debts incurred will also be included and reduce the overall asset value. Some assets may be exempt from being divided. Again, depending on the province, these can be inheritances received, personal injury awards and life insurance proceeds. The family home is another special case. In most provinces and territories the family home is subject to division regardless of when the property was purchased or who purchased it. Tax form T2220 will have to be completed and your advisor can assist you with this.
How the principal residence exemption will be affected by divorce
John and Jan divorced in 2010. During their marriage the couple owned a cottage (purchased in 2000) and a city home (purchased in 1994). As part of their divorce, they sold the cottage, and Jan kept the city home. They sold the cottage tax-free by using the PRE available to them. That is, they designated the cottage as their principal residence for the years 2000 through 2010, and paid no tax.
Now, four years later, Jan wants to sell the city home that she owns. She'll be able to designate the home as her principal residence for the years 1994 through 1999 (because she and John did not use up those years when designating the cottage sold earlier), and for the years 2011 through 2014 (because she is entitled to her own PRE after their divorce), for a total of 10 years. But the home has been owned for a total of 20 years.
Years after her divorce, a good portion of Jan's capital gain on the home will be taxable. She may not have expected that.
What if John and Jan had not sold the cottage when they divorced? Rather, what if they had each kept one of the properties? In that case, the first person to sell their property might "win the race" to claim those years while they were married and designate their own property as a principal residence for those married years. This suggests that any good separation or divorce agreement should clarify how the PRE will be claimed upon a subsequent sale of a particular property.
As a side note, you'll each be entitled to your own PRE after you're living apart only where you have a written separation agreement or a court order in place. Similarly, if you each own a property on the day you get married, you may want a marriage contract that details who will be entitled to the PRE for years prior to a divorce.
Sharing pension assets
Canada Pension Plan credits earned by both spouses during marriage can be combined and split without any immediate tax implications. Other pension plan assets can often be split without tax consequences, but speak to a lawyer in your province, since family law and pension law are provincial matters. With a Defined Benefit plan, (where what the pension pays you when you retire is based on a formula) in most jurisdictions the amount to be divided will be based on a lump sum payment at the time of separation as if the pension was being terminated at that time.
Pensions are designed to provide benefits to support the pension member for their retirement years. This is why most pensions are ‘locked in’. You can’t simply withdraw the money. In most cases, this locking-in will also apply to the benefits transferred due to a relationship breakdown. There will be a number of options to consider with respect to the transfer of pension benefits. Your advisor can take you through what option works best for you.
You will need to contact your pension administrator when a transfer of pension benefits is required. They can assist you in explaining the options and how the transfer will be made. Special forms will have to be completed. Your advisor can also help you with this process.
Tax on support payments
If one parent has custody of children, then the UCCB will be paid to that parent. With shared custody, you can apply to split the payment equally between the two of you. Spousal-support payments are generally deductible to the payer, and taxable to the recipient. Lump-sum payments that reflect arrears support for prior years are generally taxed when received, but the recipient can request to be taxed as though they were received in those prior years if this works out better and if the amount that applies to previous years is $3,000 or more (not including interest). Child-support payments are generally tax-free to the recipient and not deductible by the payer (an exception applies with some pre-May, 1997, support orders or agreements).
Taxes are can be complex depending on your specific needs. It is important that you seek a qualified tax professional to determine what taxes will be filed and by which parent.
Tim Cestnick, FCPA, FCA, CPA(IL), CFP, TEP is President and CEO of WaterStreet Family Offices.