The principal residence exemption rules permit a Canadian resident to eliminate all or a portion of the capital gain on the disposition of a principal residence. Historically, the Canada Revenue Agency (“CRA”) did not require taxpayers to report the disposition of a principal residence if the exemption eliminated all of the capital gain on the disposition. Starting in 2016, individuals who sell their principal residence (including deemed dispositions) must report the sale on their income tax return and make a principal residence designation to claim the principal residence exemption. No three year statute of limitation period will apply in respect of dispositions of real property (not just a principal residence) if the taxpayer does not report it on their tax return.
CRA may assess or reassess the disposition at any time. A taxpayer who fails to report the disposition of a principal residence can file an amended return to correct the omission subject to a late designation penalty. It is unclear whether the principal residence designation will be allowed if the taxpayer reports the sale of the principal residence by amending their original tax return (as opposed to reporting the sale on the initial filing). A new penalty of up to $8,000 will apply if CRA accepts your late principal residence designation.
The “one-plus rule” was designed to overcome the problem when a taxpayer sells a principal residence and replaces it with a new one in the same year. A taxpayer is only permitted to designate one of those properties as a principal residence for that year, raising the possibility that capital gains tax may arise on one of the properties. The one-plus rule will be available only to taxpayers who are resident in Canada in the year the property is acquired.
Under the current rules, a housing unit owned by a personal trust will qualify as a principal residence if the trust designates the property as a principal residence and the designation identifies each individual who is a “specified beneficiary” (an individual who is a beneficiary of the trust and who {or whose current, former spouse/common law partner or child} ordinarily inhabits the housing unit in the taxation year). Commencing January 1, 2017, the trust must be an “eligible trust” one of whose “eligible beneficiaries” is resident in Canada and is a specified beneficiary of the trust.
Eligible trusts include:
- an alter ego trust,
- an inter vivos or testamentary spousal or common law partner trust,
- a joint spousal or spousal trust,
- a testamentary trust that is a qualified disability trust, or
- an inter vivos or testamentary trust the benefit of a minor child of the settlor where both of the child’s parents died before the start of the year.
An eligible beneficiary is one where the trust’s terms provide the beneficiary with a right to use the housing unit.
The “eligible trust” changes would prevent some trusts that own a housing unit on December 31, 2016 from claiming any Principal Residence Exemption on a disposition of the housing unit. A new transitional rule provides some relief to those trusts. In the year the trust disposes of the property, the gain is separated into two periods. The capital gain that accrued to December 31, 2016 is eligible to be reduced by the current principal residence exemption rules. Any remaining capital gain will be subject to tax if the trust is not an “eligible trust”. The transitional rule uses the “fair market value” of the housing unit on December 31, 2016. We recommend that trusts which may have to rely on the transitional rule have a valuation of the housing unit prepared now to support a future claim for Principal Residence Exemption.
