Tax implications of transferring property to related parties (but not a spouse)

In many circumstances, a parent may wish to transfer some of their assets to their children, or a sibling may wish to transfer assets to another sibling for little or no consideration.  Such gifts are typical amongst family members, but before the asset is transferred, the parties should first consider the tax implications of making such a gift.

For income tax purposes, if a person transfers property they own to a related party, they are deemed to dispose of the asset at fair market value.  If there is a gain, the transferor will be taxed on the resulting gain.  For example, if Dad gifts the family cottage to his daughter which Dad purchased for $100,000 and now has a fair market value of $300,000, Dad will be deemed to sell the cottage for proceeds of $300,000, and will realize a gain of $200,000 ($300,000-$100,000) which must be reported on Dad’s income tax return for the year the transfer occurred.  For tax purposes, daughter will be treated as if she paid $300,000 for the cottage (so if daughter eventually sells the cottage for $400,000, daughter will realize a gain of $100,000 ($400,000-$300,000) which daughter will pay tax on).

If instead of gifting the property, Dad and daughter agree that daughter will purchase the cottage from Dad for $100,000 (the amount Dad originally paid), the tax implications for Dad will be the same, but daughter will be worse off.  As in the example above, Dad will be deemed to sell the cottage for $300,000 (the fair market value) and will realize a gain of $200,000, which Dad will pay tax on.  Daughter will acquire the cottage for $100,000, which will be her cost.  If daughter sells the cottage for $400,000, daughter will realize a gain of $300,000 ($400,000-$100,000) which daughter will be taxed on.  In this scenario, tax is paid twice on a portion of the inherent gain on the cottage – once by Dad and once by daughter.

It is important to note that transfers amongst spouses may be treated differently, and these will be covered in a separate blog post.

Advance planning for any transfer of property amongst related persons is important to avoid unintended tax consequences.  If you have questions, please contact us and we will be happy to assist.

By LaBarge Weinstein’s Taxation, Tax Planning, and Tax Litigation team.

This information is correct as of the date of posted.