PREPARING FOR PROPOSED CHANGES
Many taxpayers are aware that an exemption from tax on capital gains may be available when those gains arise from the disposition of their principal residence. However, proposed changes to the Income Tax Act could limit the ability of many taxpayers to claim the principal residence exemption (the “PRE”). Trustees, in particular, need to be aware of the proposed changes.
Generally speaking, a Canadian resident individual can claim the PRE if the taxpayer owned the housing unit and it was ordinarily inhabited by the taxpayer or his or her spouse or child. In order to claim the PRE, the taxpayer must designate the housing unit as his or her principal residence. Only one property can be designated for a given year by the taxpayer, the taxpayer’s spouse and the taxpayer’s minor children. Many taxpayers are unaware of the requirement to file a designation due to an administrative policy of the Canada Revenue Agency (“CRA”) whereby the designation did not need to be filed by an individual taxpayer so long as the gain was fully exempt from tax (generally, where the housing unit was ordinarily inhabited by the taxpayer or the taxpayer’s spouse or child in each year of ownership).
Changes for Individuals
Beginning with the 2016 taxation year, if the proposed changes are enacted, failure to report a disposition of real property, even if no tax is payable, will leave a taxpayer indefinitely exposed to reassessment in respect of the disposition. Moreover, CRA has indicated it will now enforce the requirement to file a designation in all cases. As this change in CRA policy is not dependent on the enactment of the proposed legislation, taxpayers should expect the CRA to enforce the designation requirement in future.
Changes for Non-Residents
The current rules provide for a “bonus” year of ordinary inhabitation, which is intended to provide relief for taxpayers who move and thereby have two principal residences (only one of which can be designated) in a single taxation year. The proposed changes would deny the “bonus” year to taxpayers who were non-residents of Canada in the year the housing unit was acquired.
Changes for Trusts
Under the current rules, a personal trust that owns a housing unit occupied by a beneficiary of the trust can, if certain requirements are met, claim the PRE. Under the proposed new rules, the PRE is only available to specific types of personal trusts for Canadian-resident beneficiaries, namely:
- certain life interest trusts which are frequently used in estate planning and commonly referred to as “alter-ego trusts”, “spousal trusts” and “joint-spousal trusts” as well as certain trusts for the exclusive benefit of the settlor during his or her lifetime;
- certain testamentary trusts at least one beneficiary of which is a spouse or child of the settlor who qualifies for the disability tax credit; and
- certain trusts for orphaned minors.
Most existing trusts that cease to qualify under the new rules will continue to benefit from the PRE with respect to gains accrued to the end of 2016. However, gains that accrue from January 1, 2017 to the date of disposition will not be exempt from tax.
It’s Not All Bad News
The proposed legislation provides some relief for taxpayers who fail to file the designation. It also creates additional opportunities for trusts to plan for the changes. However, practitioners should note that some of the proposed changes that enable proactive planning will not come into force until the date of Royal Assent.
First published in the April 2017 issue of BarTalk.