Tag: principal residence exemption
Changes made in 2016 to the Income Tax Act resulted in unfair treatment to disabled Canadians by restricting which types of trusts were eligible for a “principal residence exemption” (PRE). Now the Department of Finance has issued a letter of comfort, attempting to rectify these unfair changes.
What is the PRE?
In short, the PRE allows Canadians, when selling their principal residence, to avoid being taxed on their realized capital gains. Without this exemption, someone selling their principal residence would be taxed on 50% of their capital gains, which could be very significant when taking into account the value of the property.
Injustice with the Current Rules
The changes introduced in the Income Tax Act in 2016 meant only three categories of trusts could claim the exemption. The first was life interest trusts, the second was qualified disability trusts, and the third was inter vivos or testamentary trusts established for a minor child with one or more parents being deceased.
This definition significantly restricted the type of trusts that were eligible to claim the PRE. Because the second category, qualified disability trusts, are testamentary trusts (resulting from death), this meant that disabled taxpayers who were the beneficiaries of inter vivos trusts (not resulting from death) could not claim the exception and would have capital gains on their principal residence taxed at the highest rate.
In practice, this would result in an unexpected and significant amount of income tax being due 21 years after the creation of the trust, because after 21 years the trust will have been deemed to have disposed of its capital property. If a disabled beneficiary did not have enough funds available in the trust to pay the capital gains tax, there could be severe consequences.
In response to this problem, the Department of Finance has issued a comfort letter stating that it will make recommendations to the Minister of Finance to fix the issue. This would involve amending the Income Tax Act to permit certain inter vivos trusts to claim the PRE. This would also be subject to certain conditions. Firstly, the beneficiary needs to be a resident in Canada who is disabled (able to claim the disability tax credit). Secondly, the beneficiary must be a child, spouse, common-law partner, or former spouse or partner of the trust’s settlor. Thirdly and finally, no one other than the qualifying disabled beneficiary can receive the income or capital of the trust. If these three conditions are satisfied, the disabled beneficiary would be able to claim the tax exemption for their principal residence.
Fixing the injustice
This proposal was made recently and has not yet been implemented. Any laws that put disabled Canadians at a disadvantage, even inadvertently, ought to be changed and the injustice should be corrected. Implementation of these recommendations would be welcome and cannot arrive soon enough.
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Suzana Popovic-Montag & Sean Hess
On October 3, 2016, the Minister of Finance announced changes to the Income Tax Act. The purpose of these changes is to “improve tax fairness by closing loopholes surrounding capital gains on the sale of a principal residence.”
Although we have previously blogged on the proposed new reporting requirements, there are certain other proposals that merit further discussion.
Limitation Period and Tracing
One change concerns the current limitation period and tracing dispositions of principal residences. Currently, the rules are formulated so that the Canada Revenue Agency (“CRA”) may be barred from assessing or re-assessing an individual, including a trust, for taxation years that end on the third year after the date the CRA issued a Notice of Assessment.
Under the new rule, there will be no limitation period for a taxpayer’s disposition of a principal residence if it is not reported, which may allow the CRA to assess the disposition at any time.
Principal Residence Owned in a Trust
The changes also restrict when a trust may designate a property as a principal residence.
To qualify under the new rules, the beneficiary of the trust must personally reside in the proposed property. Furthermore, only three types of trust may designate a principal residence:
- Certain joint spousal and alter ego trusts for the exclusive benefit of the settlor and settlor’s spouse or common-law partner;
- Testamentary “qualified disability trusts” for the benefit of the child or a current or former spouse or common law partner of the settlor; and
- A trust for the benefit of the settlor’s minor child, where the child’s parents died in the preceding year or years.
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As you may have heard, new rules have recently come into effect that may not only have a stabilizing effect on the housing market in Canada but also usher in new Canada Revenue Agency (“CRA”) reporting requirements.
Until recently, when an individual sold their home, they did not have to report the sale on their income tax return to take advantage of the principal residence exemption. However, on October 3, 2016, the Canadian government announced that, starting with the 2016 taxation year, the sale of a primary residence must be reported to the CRA to receive the benefit of the principal residence exemption. This new reporting requirement will apply to any sale that took place on or after January 1, 2016.
The principal residence exemption is a benefit that provides a vendor with an exemption from capital gains earned on the sale of a property that has been used as their primary residence. The exemption will apply for each year the property was designated as their primary residence.
With the new reporting requirement in place, to benefit from the principal residence exemption, the CRA will only allow the principal residence exemption if the sale and designation is reported. Accordingly, estate trustees and tax professionals should pay careful attention during the preparation of income and terminal tax returns to ensure compliance with this reporting obligation.
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