Financial Planning Post-Divorce: Rebuilding Your Financial Life in Ontario

Divorce is a legal process, an emotional one, and a tax event, and the third gets attention last. That ordering is understandable and expensive, because several of the decisions made during the legal process are irreversible once the agreement is signed.

This article covers the Canadian tax mechanisms that operate on a separation in Ontario, in the order they arise, with the ones that are most often described incorrectly flagged as such.

The five things that decide your outcome

Everything below is one of those rows.

Property transfers: the rollover is the default, not a deemed sale

This is the point most commonly stated backwards, including in a great deal of material written for a Canadian audience.

When capital property is transferred to a spouse or to a former spouse in settlement of rights arising out of the marriage, subsection 73(1) of the Income Tax Act applies a tax-deferred rollover. The transferor is treated as having disposed of the property at its adjusted cost base, so no capital gain arises on the transfer. Depreciable property rolls at undepreciated capital cost. The CRA describes the mechanism under transfers of capital property.

So a rental property with a $300,000 accrued gain does not generate a $300,000 gain when it moves across in the settlement. The recipient inherits your cost base and the gain lands on them when they eventually sell.

Two consequences, and both are planning opportunities rather than trivia.

The embedded tax has to be priced into the division. An asset with a large accrued gain is worth less than an equal amount of cash, because the recipient carries the future tax. Dividing a $700,000 property against $700,000 of cash as though they were equivalent hands one party a liability the other does not have. This is the single most common way an “equal” settlement is not equal.

You can elect out of the rollover, and sometimes should. The transferor may elect in the return for the year of transfer not to have subsection 73(1) apply, in which case the disposition occurs at fair market value. That is worth considering where the transferor has unused capital losses, where the property is in an accrued loss position, or where the transferor’s income in the year is unusually low. It is a per-property decision made on a return, so it must be identified before the return is filed.

Note separately that the attribution rules on income and on capital gains stop applying once the parties are living separate and apart because of the marriage breakdown, though for capital gains a joint election is required. The general attribution framework is set out in income attribution rules in Canada.

Support payments: the distinction and the priority rule

Spousal support is deductible to the payer and taxable to the recipient. Child support under an order or written agreement made after April 1997 is neither deductible nor taxable. The CRA’s full treatment is in Income Tax Folio S1-F3-C3.

Three conditions gate the spousal support deduction, and all three must hold:

• The amount is periodic, not a lump sum
• It is paid under a court order or written agreement
• The order or agreement is registered with the CRA where required, using Form T1158

Then the rule that catches payers, and that almost no non-specialist article mentions:

Child support has priority. Where both obligations run to the same recipient under the same order or agreement, and the payer is in arrears on child support, only the amount paid in excess of the full child support obligation is deductible as spousal support. Fall behind on child support and your spousal support deduction is reduced or eliminated for that year, even though you paid the spousal amount in full.

That asymmetry has a practical corollary: pay child support first, in full, every period, and keep the record. It is not just the moral order, it is the tax order.

The eligible dependant credit, which the payer usually cannot claim

The article you read somewhere saying a support payer can still claim the amount for an eligible dependant is, in the ordinary case, wrong.

If you are required to make child support payments for a child, you cannot claim the amount for an eligible dependant on line 30400 for that child. There is a narrow exception for the year of separation, where you may claim the amount if you do not also claim a deduction for support paid, and you choose which is worth more.

Where both parents pay support to each other under a shared arrangement, the claim is available but only to one of them, and only if they agree. If they cannot agree, neither gets it. This is a real, recurring, entirely avoidable loss that a single sentence in the separation agreement prevents.

Registered plans

RRSPs. A direct transfer from one spouse’s RRSP or RRIF to the other’s is made on a tax-free basis where the parties are living separate and apart and the transfer is made under a decree, order, judgment or written separation agreement relating to the division of property. It uses Form T2220. No tax is withheld, no amount is included in income, and, importantly, the transfer does not consume the recipient’s contribution room.

The failure mode here is doing it any other way. Withdrawing from your own RRSP to fund an equalisation payment is fully taxable to you and subject to withholding, and nothing about the divorce changes that. The transfer route requires the written agreement to actually say so.

FHSAs. A transfer between former spouses’ FHSAs on breakdown of a marriage or common-law partnership has its own rules, set out by the CRA.

The Home Buyers’ Plan. The limit is $60,000, not the older $35,000, and there is a specific accommodation on relationship breakdown: you may qualify even if you would otherwise fail the first-time buyer test, where you live separate and apart from your former spouse at the time of withdrawal and began doing so in the year of the withdrawal or one of the four preceding years. Conditions apply and are set out on the CRA’s Home Buyers’ Plan pages. The general mechanics are in the RRSP Home Buyers’ Plan.

Workplace pensions. In Ontario a registered pension plan is divided under the Pension Benefits Act using a prescribed valuation, and the amount transferred to the former spouse is capped at 50% of the value that accrued during the spousal relationship. This is administered by the plan, on prescribed forms, and it is a distinct process from the equalisation calculation itself.

CPP credit splitting: the one everybody forgets

Canada Pension Plan contributions made during the period you lived together can be divided equally between you, regardless of which spouse earned them, and whether or not one of you contributed at all. Service Canada calls this credit splitting.

Three things worth knowing:

• Either former spouse can apply, and it can change the future benefit for both
• The division is permanent
• The last calendar year you were together is excluded from the division

For a couple where one partner was out of the workforce raising children, this is often worth more than several years of support payments and it costs a form. It is also frequently addressed in the separation agreement itself, so read what yours says about it.

Credit splitting is one of a small set of mechanisms that exist because Canadian retirement savings are indexed to earnings, which means an interrupted career compounds into a smaller pension rather than simply a smaller salary. The child-rearing provisions are the other one people leave unclaimed, and both are set out alongside the numbers in what the wage gap costs and how to recover it.

Ontario: equalisation, not a 50/50 asset split

Ontario does not divide assets item by item. Under the Family Law Act, each spouse calculates their net family property, being the growth in their net worth between the date of marriage and the date of separation, subject to exclusions, and the spouse with the larger figure pays half the difference to the other as an equalisation payment.

Two consequences that matter financially:

• The matrimonial home is treated specially and its value at the date of marriage is generally not deducted, which surprises the spouse who brought it into the marriage
• Because equalisation is a payment, not a transfer of specific assets, the parties choose which assets move. That choice is where the rollover, the embedded capital gains tax and the RRSP transfer rules above all become live decisions

Principal residence, after separation

While you are spouses you form a single family unit and only one property can be designated a principal residence for a given year across the two of you. Once you are living separate and apart and no longer spouses for tax purposes, that constraint no longer binds you jointly, and each can designate for the years after separation.

Where a cottage or a second property is in play, the designation years are worth modelling before the agreement fixes who keeps what. The mechanics of the designation and the plus-one rule are in the principal residence exemption.

The order of operations

1. Tell the CRA your marital status changed, since the Canada child benefit and the Canada Groceries and Essentials Benefit, formerly the GST/HST credit, are recalculated on household income and an overpayment becomes a debt.
2. Get an accurate cost base for every capital asset in the pot, before dividing anything.
3. Decide, per asset, rollover or elect out, and record the decision.
4. Make sure the agreement expressly authorises any RRSP or FHSA transfer, in the words the plan administrator will need.
5. Separate child support from spousal support explicitly in the agreement, and register it where required.
6. Apply for the CPP credit split.
7. Update beneficiary designations on registered plans and insurance, and the will. In Ontario a divorce does not automatically undo every designation, and assuming it does is how an ex-spouse inherits an RRSP.

Step 7 sits next to the estate side of the file, covered in Ontario estate planning and probate tax minimisation, and the general status rules are in tax on marriage and common-law status.

What this is worth

The largest recoverable items in a typical Ontario separation are the embedded capital gains tax that nobody priced, the spousal support deduction lost to a badly drafted clause, and the CPP credit split nobody applied for. All three are fixed at the drafting stage and are difficult or impossible to fix afterwards.

If you are negotiating a separation agreement and want the tax consequences of the proposed division modelled before you sign rather than discovered at filing time, that is the right point to have the conversation.