The sale of a house by a spousal testamentary trust and the purchase of a new residence in replacement of the former may result in adverse tax consequences if all required precautions are not taken prior to the fact.
EXEMPTION FOR PRINCIPAL RESIDENCE
When a spousal testamentary trust gains possession of a house following the death of a taxpayer and thereafter wishes to dispose of it, the availability of the principal residence exemption to reduce the taxable capital gain resulting from the transfer must be ascertained.
Furthermore, the tax act1 provides for certain presumptions when a taxpayer disposed of a house in favour of a spousal testamentary trust through a tax rollover upon death so the trust can benefit from the principal residence exemption for the years during which the deceased taxpayer owned the house.
Generally a spousal testamentary trust may benefit from the principal residence exemption upon the sale of the house for all the years during which the deceased taxpayer or the trust itself owned it, to the extent that several conditions are met.
One of these conditions is that when the trust was the owner of the residence, the residence must have been ordinarily inhabited by a specified beneficiary, by the spouse or common-law partner or the former spouse or common-law partner of such beneficiary or a child of such beneficiary. A specified beneficiary generally means any person benefi cially interested in the trust who ordinarily inhabited the housing unit (or has a spouse or common-law partner or former spouse or common-law partner or a child who ordinarily inhabited the housing unit).
Furthermore, prior to designating the house as principal residence for the years of ownership by the deceased taxpayer while he or she was living or by the trust itself, the trust must also ascertain that no principal residence designation on another property has been made in respect of these years, neither by the deceased person or his or her family unit, nor by a specified beneficiary or his or her family unit.
MAINTENANCE OF TESTAMENTARY TRUST STATUS
In the context of a transaction for the sale and purchase of residences involving a testamentary trust, one must be careful not to jeopardize the testamentary trust status of this trust, which benefits from taxation at progressive rates.
Therefore, in order to retain its testamentary trust status, no item of property must be contributed to the trust otherwise than by an individual on or after his or her death and as a consequence thereof. The trust could then lose its testamentary trust status and related tax benefits if, for example, it does not deal at the fair market value when acquiring the new residence: the seller may be considered as having made a contribution equal to the excess of the fair market value of the property over the fair market value of the consideration paid by the trust.
Subject to certain exceptions, the testamentary trust status of the trust may also be lost if the trust incurs a debt or any other obligation owed to, or guaranteed by, a beneficiary of the trust (for example, the spouse of the deceased person) or another person with whom a beneficiary of the trust does not deal at arm’s length.
The tax consequences of transactions involving real property transferred by or to a spousal testamentary trust should always be carefully reviewed beforehand in order to avoid unpleasant surprises.