Tracing – a Guide to Maintaining Exemption Claims

When dividing family property, exemption claims can quickly tip the scales in property division. The difficulty arises where exempt property is co-mingled with other family property or deposited into new property, which can reduce or dispose of an exemption claim.

Exemptions Under the Family Property Act

The presumption under section 7(4) of the Family Property Act is that property acquired during the relationship shall be distributed equally unless the Court is satisfied that it would not be just and equitable to do so. This includes any property, including items such as real estate, bank accounts, investments and debts, that is acquired during a relationship.

However, section 7(2) directs that certain property can be exempt from distribution in the following circumstances:

1. The property was held prior to the relationship;
2. The property was gifted from a third party;
3. The property was acquired through inheritance;
4. The property was proceeds from a settlement or judgment arising from a tort claim; and
5. The property was proceeds from a life insurance policy.

Principles for Tracing Exempt Property

In Harrower v Harrower, 1998 CanLII 221 (AB CA) the Court held that exempt property could be traced into subsequent property to maintain the exemption claim, but there must be some evidence linking the exempt property to the newly acquired property.

The tracing principles from Harrower continue to apply and are summarized in decisions such as Lovich v Lovich, 2006 ABQB 736 and Scheffelmeier v Krassman, 2011 ABCA 64, including:

1. An exemption will be maintained if exempt property can be traced into replacement property, but some tracing must be possible;
2. Tracing can be inferred, implied or presumed, meaning that physical or accounting precision in tracing is not required, as long as a fair connection between the exempt property and replacement property can be seen;
3. If exempt property is dissipated, it loses its exemption; and
4. The consumption or dissipation of exempt property does not create any “notional debt” that must be accounted for before the balance of the family property is distributed.

More recently, Bentley v Bentley, 2017 ABQB 53 held that an exemption can be traced forward into new property so long as there is a reasonable nexus between the exempt property and the replacement property. No precise and exact tracing is required and a minor and meaningless break in the chain can be tolerated.

If a piece of exempt property is transferred into property that is held jointly with the other spouse, or if the spouse gifts the exempt property to the other spouse or treats the exempt property as a family asset, then the value of the exemption is reduced to half, and the other half of the exempt property is presumptively equally divisible. In simpler terms, exempt property that is co-mingled with family property will presumptively result in the party claiming the exemption receiving 75% of the value of that property and opposing party receiving 25% of the value of the exempt property.

The onus of proof for the continued existence of exempt property, or its substitute, rests with the person making the assertion.

Tips to Protect Your Exempt Property

If you are in a relationship of interdependence and you want to protect exempt property from forming part of your family property, here are some tips to maintain your exemption claim:

1. Consider entering into a pre-nuptial agreement or cohabitation agreement;
2. Avoid co-mingling exempt property with other family property and specifically, avoid depositing into jointly held property; and
3. If you are transferring exempt property into a new account or a new asset, keep detailed records of the transactions in case you need to prove an exemption claim down the road.