In October, fellow blog-poster Corina Weigl wrote regarding the impact on individuals of recent changes to the rules surrounding the principal residence exemption. In addition to the changes impacting individuals, significant changes are proposed that will restrict the ability of trusts to claim the principal residence exemption residence for tax years after 2016.
Currently, a personal trust is able to designate a property held in trust as a principal residence for a year if the property was ordinarily inhabited by a “specified beneficiary” of the trust in that year and no partnership or corporation was beneficially interested in the trust in the year. The term “specified beneficiary” is defined in section 54 of the Income Tax Act and includes any beneficiary of the trust who ordinarily inhabited the property during the year or who has a spouse, former spouse or child who ordinarily inhabited the property during the year. The designation of the property as a principal residence by the trust for year results in the property being deemed to be the principal residence of every specified beneficiary of the trust for that year. The spouse and minor children of a specified beneficiary will also be unable to claim the principal residence exemption in respect of other property for that year.
The proposed rules add additional eligibility criteria which a trust must meet before being able to designate a property as a principal residence. For each tax year after 2016, a trust must be a spousal or common-law partner trust, an alter ego trust, a qualifying disability trust or a trust for the benefit of a minor child whose parents are deceased in order to claim the principal residence exemption. In addition, the specified beneficiary who ordinarily inhabited the property, or the specified beneficiary’s family member who ordinarily inhabited the property, as the case may be, must be resident in Canada for each year the designation is made.
Current subsection 40(7) of the Income Tax Act continues to provide some relief to these measures. This subsection provides that a beneficiary to whom property is distributed, on a tax-deferred basis per subsection 107(2) of the Income Tax Act, will be deemed to have owned the property continuously since the trust last acquired it for purposes of the principal residence exemption. This allows a beneficiary to claim the principal residence exemption when he or she sells the home for the years that the property was held by the trust. The proposed amendments expand this relief to trusts to which subsection 40(7) would not have applied because of the application of subsection 75(2) to the trust (and the resulting inability to transfer property to beneficiaries on a tax-deferred basis per subsection 107(2)).
Unfortunately, there are many circumstances in which it may not be advisable for the trust to transfer property to a beneficiary prior to that property being sold. This may be the case, for example, where beneficiaries have creditor issues or other problems with managing funds or where there is a disabled beneficiary and the trust does not qualify as a qualified disability trust (e.g. because another trust has already been designated as the qualified disability trust). In these cases, more extensive planning may be necessary to mitigate the adverse impact of the proposed changes. The good news is that trusts that are currently able to claim the principal residence exemption will continue to be able to do so on gain accrued up to and including the end of 2016. However, thereafter this benefit may no longer be available.