Usufruct and Rights of Use in Québec: Tax Issues to Consider

Would you like to transfer a home, cottage or rental property to your children while retaining the right to use it? A usufruct or right of use may help you arrange that transfer. These rights can also be created in a will to provide for a surviving spouse while preserving an eventual interest for children.

The arrangement needs careful estate planning. The legal rights you create and their tax treatment are not always as straightforward as they appear.

What are a usufruct and a right of use?

Under Québec civil law, a usufruct allows one person, the usufructuary, to use and enjoy property owned by someone else while preserving its substance. Depending on the property, this can include receiving the income it produces. The person who retains ownership subject to that right is commonly called the bare owner.

A right of use is generally narrower. It allows its holder to use another person’s property and benefit from what it produces to the extent of the holder’s needs and those of the people living with or dependent on them. A right of habitation concerns the use of a dwelling. The precise rights and obligations depend on the legal arrangement.

For example, a parent might transfer the bare ownership of a cottage to a child while retaining a right to use it. Alternatively, a will might provide a surviving spouse with a right to occupy a home before the children receive full enjoyment of the property.

Why can these arrangements create tax consequences?

Keeping the right to use a property does not automatically defer tax on its transfer. For Canadian income tax purposes, an usufruct or a right of use or habitation governed by Québec law is generally treated as a deemed trust. Québec also has rules governing the tax treatment of these arrangements.

Tax consequences may arise when the arrangement is created, while it is in place, when the right ends, when the property is sold or following a death. Depending on the structure and the property involved, a person transferring an interest during their lifetime may have to recognize a capital gain even though they continue to use the property.

The analysis should also consider who reports any income from the property, whether a principal residence exemption could apply and what filing obligations the arrangement creates.

What changes when a spouse or children are involved?

Timing matters. An arrangement established during the owner’s lifetime can have a different result from one created by a will.

When a deceased person’s property passes to a qualifying spouse or a trust for that spouse, a tax-deferred rollover may be available if its conditions are met. Under federal tax rules, a Québec usufruct or right of use or habitation created by will is treated as a testamentary trust for this purpose. The rollover should therefore be assessed against the specific terms of the will.

A lifetime transfer to a child while retaining an usufruct or right of use calls for a separate analysis; the spousal rollover should not be assumed to apply. If the property rises in value over time, the plan should also establish when a gain might be recognized and who would bear the resulting tax.

Which assets require particular care?

The consequences can be especially significant for:

• a cottage or other secondary residence, which may have a substantial unrealized gain;

• a rental property, which also raises questions about rental income and expenses;

• business shares, where ownership and income rights must be clearly defined; and

• foreign property, which may involve additional reporting requirements and tax rules in another country.

For a home, eligibility for the principal residence exemption should be reviewed rather than presumed. The CRA recognizes that special rules apply to property subject to a Québec usufruct or right of use or habitation.

Is a usufruct right for your estate plan?

An usufruct or right of use can help you balance a loved one’s need to use property with your wish to pass it on to someone else. Its tax results, however, depend on the property, the people involved, the wording of the arrangement and when it takes effect.

Before transferring bare ownership or adding one of these rights to a will, have the legal, tax and estate consequences reviewed together. Mallette’s tax professionals can help you assess the proposed structure and how it fits your broader estate plan.