The recent BC Court of Appeal decision in Zeitler v. Zeitler Estate, 2010 BCCA 216 illustrates why tax consequences must be thought through carefully even on an apparently simple transfer of property to a spouse.

In 1984 and 1985, Mrs. Zeitler purchased two rental properties using her own money and borrowing from the bank. In 1987, she transferred both properties to her husband Mr. Zeitler. The documentation consisted of little more than the relevant land transfer forms. From that date, he managed the properties and collected the rents.

Mr. Zeitler died in 2007, leaving no will. He was survived by Mrs. Zeitler and by his children from a previous marriage. Under BC’s intestacy laws, the children were entitled to essentially 2/3 of his estate. The properties had increased in value significantly so that a large capital gain was realized on his death. However, Mrs. Zeitler’s accountants determined that due to the transfer of the property from Mrs. Zeitler to Mr. Zeitler, the spousal attribution rules in the Income Tax Act would attribute the gain back to her. The result would be that she would benefit from only 1/3 of the value of the property under the estate, but would be required to pay the tax on the entire capital gain.

At trial, Mrs. Zeitler first argued that she remained the beneficial owner of the lots. Being unsuccessful on that ground, she also asked the court to find that when she transferred the property to her husband, it was an implied term in the (unwritten) contract that he would pay any capital gains tax liability arising on a future disposition. At trial, the court found there was no evidence to support such an implied term. However, on appeal, the Court of Appeal accepted that this indemnity was part of the contract. Mr. Justice Low stated as follows:

“It seems to me to be obvious that, if asked at the time they formed the contract which of them was to be responsible for the tax, both parties would have said that Mr. Zeitler would be responsible. He acquired both the legal and beneficial interest in the property. He was entitled to the gain for his sole use.”

The court went on to say that this term should not necessarily be implied in every transfer of property between spouses, but that whether or not it applies “will depend on the circumstances in each case”. Given the uncertainty this approach creates, any transfer of property to a spouse should include terms to address who will bear the burden of future tax consequences relating to the property.