28 Feb 2020
Changes to the Principal Residence Rules
*UPDATED Feb 28, 2020*
In a September 4, 2019 comfort letter, the Department of Finance proposed to allow intervivos trusts that have a beneficiary eligible for the disability tax credit, to claim the principal residence exemption (PRE). For clarity, an intervivos trust is set up while the settlor is alive, while a testamentary trust is set up in a person’s will or upon their death.
Changes to the PRE rules in 2016 limited the eligibility for the PRE to certain trusts only. One of these is a Qualified Disability Trust (QDT), however it is a testamentary trust (not an intervivos trust).
The comfort letter has listed several conditions that must be met, in order for an intervivos trust to claim the PRE:
A beneficiary of the trust is an individual resident in Canada during the year who is eligible for the disability tax credit (DTC);
The beneficiary is a child, spouse, common-law partner, or former spouse or common-law partner, of the settlor of the trust; and
No person other than a beneficiary described above may, during the beneficiary's lifetime, receive or otherwise obtain the use of any of the income or capital of the trust.
The second condition above would exclude a trust settled by someone other than a parent or a spouse/common-law partner. It would appear that trusts settled with funds from insurance claims or lawsuits, or from any other benefactor, would not qualify.
The third condition above would appear to exclude immediate family members such as children or spouses from living with the person eligible for the DTC, and could limit the ability for the person to have a roommate, a tenant or a live-in caregiver.
Should the Minister of Finance agree with the recommendations, the amendments will be retroactive to when the 2016 tax rules took effect. It is hoped that some of the concerns mentioned above will be considered and resolved prior to finalizing the amended legislation.
*POSTED Nov 24, 2016*
On October 3, 2016, the Canada Revenue Agency proposed changes to the principal residence exemption (“PRE Exemption”) rules to, as indicated by CRA, “improve tax fairness by closing the loopholes.” The following provides an overview of the main principal residence exemption changes:
1. Additional T1 reporting requirements
Despite the requirement in the Income Tax Act, the CRA had an administration position that did not require individuals to report the sale of a principal residence, if the gain was fully sheltered by the PRE exemption.
It would appear that the CRA will force this reporting the sale of principal residence starting in the 2016 taxation year, with the proposal to eliminate the normal reassessment period with respect to dispositions of real property when they are not reported. This applies to all taxpayers even if they (corporations for example) are not eligible for the PRE exemption. Generally, the normal reassessment period is 3 years for individuals and 4 years for corporations.
The proposals allow tax returns to be late-filed or amended to report these dispositions, at which time the normal reassessment period will begin. The risks of late-filing include denial by CRA resulting in a fully taxable sale, or the application of late-filing penalties equal to the lesser of $8,000 or $100 per month.
2. Limiting trusts that hold principal residences
Effective on January 1, 2017, the PRE exemption will only be available to the following types of trusts:
Alter ego trusts, joint spousal or common-law partner trusts, spousal or common-law partner trusts, or trusts for the benefit of the settlor during his/her lifetime. Depending on the type of trust, the beneficiary in respect of whom the PRE exemption is claimed must be the settlor or spouse, or common-law partner of the settlor;
A testamentary trust that is a qualified disability trust, settled by a parent or spouse, or common-law partner of the beneficiary; or
A trust for the benefit of a minor child, for whom both parents died before the start of the year in which the PRE exemption is claimed.
In all cases, the beneficiary must be a Canadian resident for the years that the PRE exemption is claimed, and he/she must have the right to use and enjoy the property as a residence. The latter must be specified under the terms of the trust for properties purchased on or after October 3, 2016.
Some examples of non-qualifying trusts include intervivos trusts set up solely to hold a principal residence, family trusts, qualified disability trusts settled by a grandparent, uncle or aunt, and trusts for the benefit of a minor child where one parent is still living.
The gain on dispositions by non-qualifying trusts after January 1, 2017 will be calculated using two time periods:
Up to after December 31, 2016 in which the PRE exemption is available if all the criteria are met
And beginning January 1, 2017 in which the PRE exemption is not available.
The gain in the first time period involves a notional disposition at fair market value (“FMV”) on December 31, 2016. No guidance has been provided with respect to the determination of this FMV, however, we would recommend at a minimum, to retain the 2017 property tax assessment.
The proposals will allow a non-qualifying trust to “roll” a principal residence to a beneficiary on a tax-deferred basis and for the purpose of making the principal residence designation; the beneficiary may consider the years that the trust owned the property as if he/she owned the property. We would caution that the review of this tax-deferred option should also consider the applicability of property transfer tax.
3. Eliminating the “1+” real estate rule for non-residents
The PRE calculation includes a “1+” factor to recognize that taxpayers may buy a new home and sell an existing home in the same year. This allows a taxpayer to claim the PRE exemption on both homes with respect to that same year, despite the rule that only one principal residence may be designated for a calendar year. For properties disposed of after October 3, 2016, the “1+” factor will only be available to a taxpayer who was resident in Canada in the year the principal residence was purchased. This prevents non-residents from benefitting from 1 year of the PRE exemption as the “1+” factor did not previously have a residency requirement.
Individuals should share details with their financial and legal advisors about any personal-use property to ensure compliance with tax reporting, including recent sales and purchases, recent and past renovations, their residency status during the ownership period, and whether there are multiple properties owned. This will ensure that personal tax returns are not exposed to an indefinite reassessment period.
Trusts that hold principal residences should be reviewed prior to December 31, 2016, so that all available options can be considered in a timely manner.
The above content is believed to be accurate as of the date of posting. Canadian Tax laws are complex and are subject to frequent changes. Professional tax advice should be sought before implementing any tax planning. Manning Elliott LLP cannot accept any liability for the tax consequences that may result from acting based on the information contained therein.