When it comes to the division of dollars in divorce it’s important to understand that not assets measure up, dollar for dollar. Often times, one spouse will want to keep more of one asset and swap out another. One spouse may want to keep the matrimonial home and give some of their retirement dollars, in their RRSP, to their spouse to ‘buy’ out their ownership in the family home. What needs to be considered, here, is the tax repercussion of the asset swap. The matrimonial home is a tax-free asset and the RRSP is not. The matrimonial home, if it is deemed the principle residence, can be sold and it is a non-taxable event. If your home sells for $500,000 then that’s what you get (minus any real estate sales commissions and other costs that are associated with the sale) and there are no taxes. The RRSP, however, has some embedded tax associated with it. A $100,000 RRSP is not worth $100,000 because when the registered owner starts to withdraw these funds they are taxed. Solution? There is often an inclusion to offset the embedded tax liability on the Net Family Property form to offset the tax liability. Financial Planners or Accountants can calculate the embedded tax liability as either party may have a different tax bracket based on the size of their retirement savings.
What happens when an equalization payment is due to one spouse from another? A payment can be made by either transferring retirement assets or non-registered funds. Using non-registered funds, the owing spouse can either transfer assets from an investment portfolio to the receiving spouse or they can make a cash settlement. If the paying spouse choses to pay what is owed by transferring assets from a joint investment account then the embedded tax should be considered. Let’s look at this example:
The joint investment account holds four different investment holdings.
1,000 shares of ABC were purchased at $30 creating a book value of $30,000. The current market value is $45,000 so there is a $15,000 capital gain.
1,000 shares of DEF were purchased at $20 creating a book value of $20,000. The current market value is $10,000 so there is a $10,000 capital loss.
1,000 shares of GHI purchased at $15 creating a book value of $15,000. The current market value is $5,000 so there is another $10,000 capital loss.
1,000 shares of JKL were purchased at $30 creating a book value of $30,000. The current market value is $30 so there are no capital gains or loss associated with this investment.
If the equalization payment is $45,000 then it would benefit the receiving spouse to receive the last three positions totalling $45,000 with the $20,000 of capital loss rather than receiving the first investment position worth the same $45,000 with the $15,000 of capital gain.
Being mindful that a dollar isn’t always a dollar when considering how to divide matrimonial property is a large consideration. The effect of tax on assets must also be considered…..amongst other things.