All About Estates

The Principal Residence Exemption: Can you Divide and Conquer?

Recently, the Canada Revenue Agency (‘CRA”) was asked for its opinion on a fact situation with implications on the availability of the principal residence exemption for tax purposes, that I think also has applicability to estate planning in general and to some of the issues one can encounter when trying to divide interests in a property for estate planning purposes in particular.

The CRA was provided with the following scenario. An individual taxpayer owns a single piece of land used to carry on a farming business. A farmhouse on the land is treated by the taxpayer as his principal residence. Both the farmhouse and the land on which it is located cannot be legally severed from the land used to carry on the farming business. The taxpayer wants to retain beneficial ownership of the farmhouse and land on which it is located, and transfer the remaining portion of the land to a wholly-owned corporation which would continue to carry on the farming business for him.

The purpose of the partial disposition of the farmland is to allow the taxpayer to claim a principal residence exemption from the capital gain realized on the sale farmhouse and underlying land, when the whole farmland property is sold by the corporation at a later date.

The CRA confirmed that the individual taxpayer could not claim the principal residence exemption on the future disposition of the farmland (including the farmhouse and land on which it is located) by the corporation. The CRA’s position for quite some time has been that the essential rights of ownership of a property used as principal residence, that is, the whole farmland property, not just farmhouse portion, cannot be transferred or retained separately from the rest of the property. If the taxpayer decides to transfer the property to a corporation, he loses the right of alienation (i.e., ability to transfer the property). The rights of possession and alienation are two essential elements of ownership in the context of a principal residence. Without those rights, the taxpayer stops owning the farmhouse after the sale to the corporation and therefore cannot claim a principal residence exemption at a later date.

So, no you can’t always always divide and conquer. Consult with the pros first.

Happy Reading

About Steven Frye
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