income tax on cabin during divorce


I am currently in the process of divorcing my wife.  I jointly, with my wife and my 2 siblings and their spouses, own a cabin and recreation property in the interior, which has increased in value approximately $350,000 over 8 years.  We (all the owners) are in the process of selling this property.  My question is;  If I 'trade off' my interest in our family home to my wife for her portion of the recreation propery, can I claim the recreation property as my principle residence to avoid paying capital gains? 

david ingram replies:

The question does not match the female email address but that does not matter for the answer.

It does, however, remind me of the old story of the fellow who walks into his lawyer's office and explains a case he wants to sue over and the lawyer looks pleased and says 

"you have a win there Rick!

Rick looks disappointed and gets up to walk out and the lawyer asks him why he does not appear happy. 

Rick says, "I told you the other sides's case".

The answer to your question is that either your 1/6 share of the cabin or your 1/2 share of the family house can be tax free for both your spouse and yourself at the same time.  If you trade off the house for the cabin and the two of you elect to make the house tax free,  your share of the cabin can be tax free from the date of the trade-off but everything for you AND your spouse up to that date is taxable.  I am assuming here that the family home went up more than your share of the cabin.

When making the trade with your spouse, the lawyers should take your tax liability into account when figuring the trading dollar amount.

As an example, I want to assume that 'miraculously', you and your spouse were the owners of a $600,000 family home and a $600,000 ski cabin at Whistler.

Co-incidently, you had paid $200,000 for both properties and had never rented either unit out and they are both paid for.

.Family lawyers in this case, regularly trade off the house for the chalet and it seems even because you both end up with a $600,000 piece of real estate.

However, the tax situation looks like this.

If, in the divorce, you take over the ski chalet at your spouse's acb ($100,000) you now own a piece of property which has a taxable $400,000 capital gain inthe future -  If you were to sell it the next day, you would owe from $70 to 88,000 while your spouse would owe nothing if they sold the family home the next day.

There is a solution. 

As a person, you can elect to consider either your share of the chalet or the family home to be tax free and so can your spouse.

Therefore, your spouse should consider their share of the chaplet to be youir spouse's tax free piece of property up to the date of separation or divorce and you should consider your share of the family home to be your tax free residence.  That way, your spouse would transfer their share of the chalet to you at $300,000 instead of the elective original ACB of $100,000.

You would do the same thing with your spouse and transfer your share of the family house to your spouse at $300,000 rather than the elective $100,000.

That leaves your spouse with the future responsibility of paying tax on thier $200,000 share of the profit on the family home in the future ($300,000 - $100,000).  The nice part here is that if your spouse stays in the house for 20 years, they does not have to pay the $35,000 or so tax. 

The same is true of you.  You do not have to pay tax on the $200,000 of profit in the ski chalet until you actually sell it.  Because any future profits are tax free, the amount of tax is frozen and as you will agree, paying $30,000 tax 10 or 25 years from now will be like paying $15,000 or $5,000 today, depending upon inflation.

Now that was mainly a political statement.  It does not apply as much in your case because 'your' cabin is about to be sold soon and the present value of a dollar will not be much of a factor. I also bet that you more likely have a $1,000,000+ house and a $250,000- equity in the cabin to deal with.  In your case, the tax liability should be calculated and an adjustment made in the settlement.

Good luck, I am living in a house that I jokingly say I have bought 4 times.  Once for $42,000, once for $56,000, once for $160,000 and the last time for $641,000.  Divorce is expensive.

When you bring this up with the divorce lawyers, I can almost guarantee they will scratch their heads. In the 35 1/2  years that capital gains problems have been in effect, I have never once met a divorce lawyer who understood it on first look.

Judge Flannigan said it best 20 years ago back in the 80's.  I can not find the quote but it went something like this.

"With all due respect I do not think my colleagues on the bench understand the tax ramifications of divorce.  I think further with all due respect that there are a great many competent atorneys who draw up divorce agreements with little or no thought given to the tax consequences thereon." 

I may be out a word or three but the thought is exactly what he said and meant.