Changes to the Principal Residence Exemption for Trusts

Since 1971, Canadian homeowners have relied on the principal residence exemption ("PRE") to reduce or eliminate taxable capital gains owing on the disposition of their principal residences. The Income Tax Act (the "Act") has provided the PRE not only to individuals, but also to personal trusts so long as the home was "ordinarily inhabited" by a "specified beneficiary" (e.g. an individual beneficiary, their spouse, common-law partner, or child).

On October 3, 2016, the Department of Finance announced changes to the Act which, among other things, aim to "improve tax fairness by closing loopholes surrounding the capital gains tax exemption on the sale of a principal residence". Beginning in 2017, the Act will impose additional and more restrictive rules about whether trusts holding principal residences qualify for the PRE.

Prior to this announcement, most personal trusts were permitted to designate properties as principal residences subject to certain conditions. However the new rules limit the designation of a principal residence to the following types of trusts:

1. Alter Ego Trusts, Spousal or Common-Law Partner Trusts, Joint Spousal or Joint Common-Law Partner Trusts, and other trusts established for the exclusive benefit of the settlor (i.e. the creator of the trust) and/or the settlor's spouse during their respective  lifetimes;
2. Qualified Disability Trusts (as defined in section 122(3) of the Act) established for the exclusive benefit of individuals who qualify for the disability tax credit; and
3. Inter Vivos or Testamentary Trusts established for minor children of deceased parents.

The beneficiary or beneficiaries of such trusts must be Canadian Residents with "a right to the use and enjoyment of the housing unit as a residence throughout the period in the year in which the trust owns the property".

For acquisitions of eligible properties by trusts on or after October 3, 2016, only the types of trusts listed above that meet the Canadian resident beneficiary requirement can benefit from the PRE. There are transitional rules for trusts that acquired an eligible property before such date where the property was owned at the end of 2016 and is disposed of thereafter. Under this scenario, the PRE will be calculated as if the property was disposed of on December 31, 2016 for fair market value and reacquired on January 1, 2017. This will have the effect of reducing the PRE for post-2016 taxation years.

Taxpayers should refer to the new rules to confirm whether their trust can claim or continue to claim the PRE. In any case, tax and estate plans that contemplate the use of a trust for PRE purposes should be re-examined to ensure that the planning is still appropriate going forward.