Treatment of Inheritance in a Divorce

Inheritance in a Divorce

By Jennifer Black

When a married couple separates in Ontario, a system known as equalization which is outlined in the Family Law Act is used to address property division. This system is often misunderstood particularly when it comes to inheritance. While inheritances received during the marriage are generally excluded from property division, there are important limitations and exceptions that can significantly affect the outcome. An inheritance that a person has coming into the marriage is treated differently than an inheritance received during the marriage. 

Understanding how inheritances fit into the equalization process is essential. Each spouse calculates their Net Family Property by determining the value of their assets on the date of separation, minus their debts and liabilities on that date, and minus the value of their assets on date of marriage and adding on any debts on the date of marriage.  Once both spouses’ net family property amounts are calculated, the spouse with the higher amount must pay the other spouse one-half of the difference that being the equalization payment.  The equalization provisions in the Family Law Act, treats marriage as an economic partnership, and spouses share in the value what they built together during the marriage, regardless of whose name an asset is registered in.  There are some exceptions to equalization, that provide for some property being excluded from equalization and one of these exceptions is inheritance received during the marriage. 

Under section 4(2) of the Family Law Act, a gift or inheritance received from a third party during the marriage is considered excluded property. This means its value is generally not included in the spouse’s net family property and is not shared.  However, this exclusion is not automatic or absolute. Whether an inheritance remains excluded depends on how it is handled after it is received.  An inheritance will usually remain excluded if it is clearly traceable, kept separate, and not used toward the matrimonial home and remains in existence on the date of separation.

An inheritance received prior to marriage is not excluded.  Rather the spouse with an inheritance coming into the marriage is given what is called a date of marriage deduction for the value of the inheritance on the date of marriage.  Therefore, the increase in value of the inheritance during the course of the marriage will be shared with the person that brought the inheritance into the marriage getting credit for the value on the date of marriage.  For example, if a person brought an inheritance of $100,000 into the marriage and then on the date of separation that inheritance is now worth $500,000.00.  The person would have to share in one half of the $400,000 increase in value of the inheritance over the course of the marriage.  If that is not the intention and the person wishes to protect the growth of their inheritance from equalization, they must get a Marriage Contract in place.

If inherited funds received during the marriage are kept in a separate account, invested independently and not co-mingled with other funds, or used to purchase non-matrimonial property, they will typically remain excluded.

The most significant risk to an inheritance arises when inherited funds are used toward a matrimonial home.  If inherited money is used as a down payment, to pay down a mortgage, or to renovate a matrimonial home, the inheritance generally loses its excluded status.  In these cases, the full value of the matrimonial home is typically shared through equalization, even if one spouse initially funded it with inherited money.  If a person wants to place inherited funds into a matrimonial home, they should consider getting a marriage contract in place prior to doing so which could then allow for the protection of that inheritance. 

A spouse claiming an inheritance as excluded property bears the burden of proof. Proper documentation and clear tracing are essential.  For example, if a person received $500,000 inheritance and put it into an investment account that is in their sole name and not co-mingled with any other funds, then they withdraw $50,000 to purchase a vehicle for themself, the remaining funds in the investment account and the vehicle would be excluded as the vehicle and investment account could be traced to the inheritance funds received. 

If inherited funds are mixed with joint accounts or family income and cannot be traced, they may be included in net family property and equalized. This is why it is important that inheritance funds be held in a separate sole account and estate documentation should be kept as well as all documentation to be able to trace the inherited funds from the original source to the asset(s) owned at the date of separation. 

Other ways inheritance can be lost are if the inheritance funds are spent on living expenses or a vacation, as the inheritance needs to still be in existence on the date of separation to receive an exclusion. 

Using inherited funds toward a matrimonial home or failing to keep clear records can permanently eliminate the exclusion of the inheritance. Legal advice is strongly recommended before inherited property is used or transferred