How can I exclude my inherited property from equalization?
As discussed in our previous post on equalization, when determining your Net Family Property (NFP), you need to calculate the value of all the property you own, both on the date of separation, and on the date of marriage, and you essentially share the increase in your net worth over the course of your marriage.
As we mentioned, there are some types of property that you do not have to include in you calculation. The value of this property gets subtracted from your date of separation net worth when calculating your NFP. This is known as Excluded Property.
The Family Law Act in Ontario outlines the types of property that are to be excluded from a spouse's NFP calculation. The types of property are as follows:
- Property, other than a matrimonial home, that was acquired by gift or inheritance from a third person after the date of the marriage;
- Any income from the above inherited property, if it has been expressly stated that it is to be excluded from the spouse's net family property;
- Damages or a right to damages for personal injuries, nervous shock, mental distress or loss of guidance, care and companionship, or the part of a settlement that represents those damages;
- Proceeds or a right to proceeds of a policy of life insurance that are payable on the death of the life insured;
- Property, other than a matrimonial home, into which property referred to in numbers 1-4 above can be traced;
- Property that the spouses have agreed by a domestic contract is not to be included in the spouse's NFP; and
- Unadjusted pensionable earnings under the Canada Pension Plan.
These rules specifically reference "other than a matrimonial home". What does that mean?
If the traced property forms part of the matrimonial home, it cannot be excluded. As discussed in a previous post in the series on the matrimonial home, the matrimonial home is treated differently for the purposes of property division. Upon separation, both spouses are entitled to share equally in the value of the matrimonial home. Therefore any money, whether received by inheritance or otherwise, cannot be excluded if it forms part of the matrimonial home. This includes money used to improve the home, to buy the home, or to pay down the mortgage.
What is tracing, and how does it work?
The Family Law Act has specific provisions that address what happens when the property that would normally have been excluded is no longer in your possession, but the value has been transferred to something else. For example: If you inherited $20,000 after the date of marriage, that property would normally be excluded from your NFP calculation. But what happens if you used that $20,000 to purchase a car, or a piece of art, and you still have those items on the date of separation?
In this scenario, you can "trace" the value of the initial $20,000 into the other items that were purchased. If you inherit a car worth $20,000, sell it, and spend that $20,000 on other items, those items can be excluded from your NFP. This is called "tracing."
An Example of Tracing
Spouse A inherits $100,000 from a third party during the marriage. With that $100,000, Spouse A does the following:
- Uses $50,000 as part of a down payment on a new matrimonial home.
- Purchases two pieces of art, valued at $12,500 each (total of $25,000)
- Purchases a new family car for $20,000
- Uses the final $5,000 to buy a hot tub for their new house
Assuming Spouse A has all these assets upon separation, what property can Spouse A exclude from their NFP?
In this scenario, Spouse A will likely only be permitted to exclude the value of the two pieces of art, with a total value of $25,000. This is because the first $50,000 forms part of the value of the matrimonial home, and therefore cannot be excluded. The value of the car and the hot tub also could not be excluded, as those purchases were for use by the entire family.
It is interesting to note in this example, that had Spouse A used the $20,000 on a car that was for their sole use, and was not for the benefit of the family, it could likely be excluded from their NFP calculation.
Keep in mind:
It is important to remember, that if the money or property inherited is used for everyday expenses such as food or travel expenses, or is invested in the matrimonial home, the property can no longer be traced.