2017-0698181E5 New principal residence rules & trusts

Principal Issues: How do new principal residence rules apply to a Graduated Rate Estate with a non-calendar year-end?

Position: Special attention must be paid to wording of proposed 40(6.1).

Reasons: Transitional rules apply.

Author: Holloway, Lena
Section: 40(6.1); 54

XXXXXXXXXX                                                                             Lena Holloway, CPA, CA
                                                                                                     2017-069818
June 16, 2017

Dear XXXXXXXXXX:

Re:  Principal Residence Exemption and Trusts

This is in reply to your email correspondence of April 7, 2017, requesting our views on the application of the proposed amendments to the definition of principal residence in section 54 and new subsection 40(6.1) of the Income Tax Act (the “Act”). Proposed subsection 40(6.1) is consequential on the introduction of new subparagraph (c.1)(iii) of the principal residence definition. That subparagraph limits the types of trusts that are eligible to designate a property as a principal residence for a taxation year that begins after 2016. You had asked us to confirm your interpretation of the proposed changes in a specific scenario outlined in your letter as follows:

Assumptions:

- An individual (Deceased Parent) died on XXXXXXXXXX.

- The Deceased Parent wholly owned a principal residence and the Deceased Parent’s adult son lived with the Deceased Parent in the principal residence.  The Deceased Parent also had an adult daughter, but she did not live with the Deceased Parent.

- The Deceased Parent did not have a surviving spouse.

- At date of death, the fair market value of the principal residence was $XXXXXXXXXX.

- There was a deemed disposition on death relating to the principal residence.  The property met all the requirements to be considered a principal residence for all years owned up to the date of death for Deceased Parent.

- Adult son lived in the home up to XXXXXXXXXX and then moved out in order to have the estate sell the home.

- Adult son and adult daughter are entitled to the residual assets of the estate pursuant to the will of Deceased Parent.

- The adult son meets the criteria for being considered a specified beneficiary of the estate pursuant to the principal residence definition in the Act.

- The estate qualifies as a Graduated Rate Estate (GRE), with a fiscal period of July 1, 2016 to June 30, 2017.

- The GRE sold the principal residence in XXXXXXXXXX for $XXXXXXXXXX.

- The GRE has a gain of $XXXXXXXXXX.

It is your opinion that the proposed new rules do not apply in this situation since the disposal did not occur in a tax year that began after 2016.  As the tax year began July 1, 2016, you have suggested that the old rules apply and that based on the above-mentioned assumptions, the GRE can designate the residence as a principal residence for its July 1, 2016 to June 30, 2017 tax year.

Our comments

The comments which follow in this letter will provide general comments about the provisions of the Act.  Our comments do not confirm the income tax treatment of a particular situation, but are intended to assist you in making that determination.  The income tax treatment of transactions will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC70-6R7, Advance Income Tax Rulings and Technical Interpretations.

In a technical backgrounder issued by the Department of Finance dated October 14, 2016, the following statements were made on page 4:

“Trusts will be eligible to designate a property as a principal residence for a tax year that begins after 2016 only if additional eligibility criteria are met. These criteria will improve fairness and integrity by better aligning trust eligibility for the principal residence exemption with situations where the property is held directly by an individual. A trust will be required to be—in each year that begins after 2016 for which the designation applies—a spousal or common-law partner trust, an alter ego trust (or a similar trust for the exclusive benefit of the settlor during the settlor’s lifetime), a qualifying disability trust, or a trust for the benefit of a minor child of deceased parents. In addition, the trust’s beneficiary who, or whose family member, occupies the residence for the year will be required to be resident in Canada in the year, and will be required to be a family member of the individual who creates the trust. Transitional relief is provided for affected trusts for property owned at the end of 2016 and disposed of after 2016.”

The October 3, 2016 Notice of Ways and Means Motion proposed amendments to the definition of principal residence in section 54 of the Act limiting the types of trusts that could claim the exemption in years beginning after 2016 and by adding the following after subsection 40(6):

(6.1) Principal residence – Property owned at end of 2016 — If a trust owns property at the end of 2016, the trust is not in its first taxation year that begins after 2016 a trust described in subparagraph (c.1)(iii.1) of the definition principal residence in section 54, the trust disposes of the property after 2016, the disposition is the trust's first disposition of the property after 2016 and the trust owns the property, whether jointly with another person or otherwise, continuously from the beginning of 2017 until the disposition,

(a) subsection (6) does not apply to the disposition; and

(b) the trust's gain determined under paragraph (2)(b) in respect of the disposition is the amount, if any, determined by the formula

A + B – C

where

A is the trust's gain calculated in accordance with paragraph (2)(b) on the assumption that

(i) the trust disposed of the property on December 31, 2016 for proceeds of disposition equal to its fair market value on that date, and

(ii) paragraph (a) did not apply in respect of the disposition described in subparagraph (i),

B is the trust's gain in respect of the disposition calculated in accordance with paragraph (2)(b) on the assumption that

(i) the description of B in that paragraph is read without reference to "one plus", and

(ii) the trust acquired the property on January 1, 2017 at a cost equal to its proceeds of disposition determined under the description of A, and

C is the amount, if any, by which the fair market value described in subparagraph (i) of the description of A exceeds the proceeds of disposition of the property determined without reference to this subsection.

When applying these legislative proposals to the disposition of the property in the scenario described above, we note that the GRE:

1. would not be, in its first taxation year after 2016, a trust described in proposed subparagraph (c.1)(iii.1) of the definition principal residence in section 54;

2. owned the property on December 31, 2016;

3. disposed of the property after 2016;

4. first disposed of the property after 2016; and

5. owned the property continuously from the beginning of 2017 until the disposition.

Given that new subsection 40(6.1) would therefore apply to the GRE described above, we do not agree with your interpretation. It is our opinion that the transitional relief offered by proposed subsection 40(6.1) would be applicable in the scenario presented to any portion of the $XXXXXXXXXX gain that accrued up to December 31, 2016.  Any portion of the gain that accrued after that date would not be eligible to be sheltered by the principal residence exemption and would be taxable.

The above comments represent our view of proposed changes to the law as it generally applies. While we hope that our comments are of assistance to you, please note that this is not an advance income tax ruling and, accordingly, is not binding on the CRA.

Yours truly,

Phillip Kohnen
for Division Director
Financial Industries and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

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