I was reminded this week of the need for advisors to consider more than division of property, support, and custody and access arrangements in the context of marriage breakdown. Taxation issues related to family residences which could qualify as a principal residence need also be considered. One of the requirements that must be met in order for a particular property to qualify as a principal residence is that only one property be designated as a principal residence for a particular year (after 1981) by a married couple. However, if spouses are separated and living apart throughout a year pursuant to a judicial separation or a written separation agreement, each may designate a residence as a principal residence with respect to that year. If not thought through in the course of negotiating a separation agreement, this can lead to unintended consequences.
Consider the example of a couple who were married in 1990, were fortunate enough to buy both a home and cottage in 1990, but whose marriage breaks down in early 2018. As part of their division of property, they each receive one of the residences. Imagine, then, that the spouse who receives the cottage disposes of it later in 2018. This spouse could potentially designate the cottage as a principal residence for the years 1990 through 2017, thereby exempting the entire gain on the cottage from tax. A good result for this spouse – who happens to be the first to dispose – but a not so good one for the other. When the home is later disposed of, the designation of it as a principal residence for the years 1990 through 2017 will not be available. The possibility of this negative outcome occurring is exacerbated by the fact that there is no guarantee that either spouse will know when property is being disposed of by each other. Nor that each will know what designations have been made with respect to years during which the couple was married. One can easily imagine circumstances where a spiteful ex-spouse could deliberately use this situation to advantage. And with the requirement now to report the disposition of a principal residence and claim the designation, the Canada Revenue Agency will now have the information to determine if excess designations have been made.
For this reason, the manner in which the “principal residence designation years” will be shared should be dealt with in any separation agreement. Whether this involves determining an optimal designation strategy based upon the annual increase in value of each property, making a compensatory payment to the non-designating spouse for some or all the taxes on the disposition of a property, notifying each other of designations when made, or merely splitting the number of years evenly between the two, an upfront consideration of this issue could avoid a client losing the designation duel.