On October 3, 2016, the Minister of Finance of Canada announced changes to the federal Income Tax Act that will affect the availability of the principal residence exemption to non-residents and those who hold their principal residence through a personal trust. The principal residence exemption generally relieves a taxpayer from paying income tax on the capital gain arising from the sale of the taxpayer's principal residence during years in which the taxpayer was a resident of Canada. In addition, the federal government implemented an extended assessment period and new reporting requirements with respect to claiming the principal residence exemption.
Elimination of the “one-plus” rule for non-residents
According to the new rules, an individual who was a non-resident of Canada in the year the individual acquired a principal residence will no longer be able to claim the principal residence exemption for that year when the individual disposes of the principal residence. Previously, the “one-plus” rule allowed an individual, who acquired a principal residence during the year in which the individual was a non-resident of Canada, to claim the principal residence exemption for that year.
New restrictions on trusts
For tax years beginning in 2017, the types of trusts that are now eligible to designate a property as a principal residence are limited to the following:
- spousal or common-law partner trusts;
- joint spousal or common-law partner trusts;
- alter ego trusts (or similar trusts for the exclusive benefit of the settlor during the settlor’s lifetime);
- qualified disability trusts; and
- certain trusts for the benefit of a minor child of deceased parents.
In order for a trust to be eligible for the principal residence exemption, the new rules require that the beneficiaries who occupy the residence be Canadian residents for tax purposes. Where a trust acquires property after 2016 that it wishes to designate as a principal residence, the terms of the trust deed must provide the eligible beneficiary with the right to use and enjoy such residence throughout the period in which the trust owns the property.
The result of these changes is that non-residents can no longer use a personal trust to claim a principal residence. However, the changes extend beyond this as Canadian residents who hold their principal residence through a trust may no longer be able to qualify for the principal residence exemption if their trust is not one of the above-listed trusts. For example, a standard family trust that holds a residence will no longer qualify, even if its beneficiaries are Canadian residents. A trust holding a residence for the benefit of a spendthrift adult child will also no longer qualify.
Transitional rules for trusts
Personal trusts that are no longer eligible to claim the principal residence exemption under the new rules will still be allowed to claim the principal residence exemption on the gain accrued up to the end of 2016, to the extent the trust otherwise qualified for the exemption. These trusts will not be able to claim the exemption in respect of any gain that accrues after 2016.
Extension of assessment period
Under the new rules, a taxpayer may be reassessed beyond the “normal assessment” period (which, for an individual or a trust, is three years from the date of the original assessment) if the taxpayer does not report the disposition of real property in the taxpayer’s tax return for the year in which the disposition occurred. This change is effective for tax years that end on or after October 3, 2016.
CRA’s new reporting requirements
In addition to the above changes, the Canada Revenue Agency (CRA) has implemented new reporting requirements for taxpayers for their 2016 income tax returns.
Starting with the 2016 income tax return, the CRA will require all taxpayers to disclose the disposition of principal residences that occur on or after January 1, 2016 in order to be eligible for the principal residence exemption. In the past, the CRA granted administrative relief to taxpayers (other than trusts) from disclosing the details relating to the disposition of a principal residence, unless the property was not a taxpayer’s principal residence for every year that the taxpayer owned it. A taxpayer will be required to provide the year the principal residence was acquired, designate the years in which the property was the taxpayer’s principal residence, disclose the sale proceeds, and provide a description of the principal residence. Failure to report the designation of a principal residence could result in a penalty of up to $8,000.