The Tax Issue:
My girlfriend (soon to be fiance) and I are seriously considering purchasing her parents home since they will be moving in six months time. Her father has offered to sell the house to us at a price that is $40,000 below the fair market value. It is my understanding that as long as I purchase the house from him before we are married (therefore not related for tax purposes), then there will be no tax consequences for him or myself on the transaction. However, I’m also of the understanding that if I purchased the house from him after we were married than there would also be no tax consequences for him or myself since he would have use of his principal residence exemption which would eliminate any tax on the deemed capital gain resulting from selling the house to me at less than FMV. Is this correct? Also, does the fact that my girlfriend will be contributing up to half of the down payment for the house impact the transaction in any way?
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You are correct when you say that the consequences to your future father-in-law are the same no matter when you make the deal. No matter what his proceeds or “deemed” proceeds are, any gain on the sale of his house will be exempt from tax (see my previous post on the principal residence exemption).
So what was your friend alluding to? Section 69 of the Income Tax Act. Let’s say the property you were purchasing was not an exempt principal residence. Section 69 contains special provisions dealing with transactions between persons who are not dealing at arm’s length. The rules are somewhat punitive in nature because they make one-sided adjustments to the price.
If the price is less than fair market value, as in your case, then the deemed proceeds to the vendor are adjusted upwards to equal that value. However, the cost to the purchaser is not adjusted and remains whatever was paid. If the price is more than fair value, the proceeds are not adjusted downward, but the purchaser’s cost is reduced for tax purposes.
So, would these rules apply to you if the sale was made before you were married? Probably, yes. The rules apply to non-arm’s length transactions. People who are related are, by definition, not at arm’s length, so if you made the purchase after getting hitched, there would be an automatic non-arm’s length situation. However, there is also a rule that states that any two people may be deemed to be not dealing at arm’s length if the facts warrant it. In your case, the facts would seem to warrant it.
Finally, the fact that your future bride is putting in part of the money won’t make any difference, because there is only one principal residence allowed between spouses, so it really doesn’t matter who makes the claim in the end, when you finally pass the property on to your kids at a generous discount, right?