Principal Residence Exemption for Home Held in Personal Trust
Arthur Drache, December 04, 2006
Most Canadians, even those who are not particularly tax oriented are aware of the fact that there is no capital gain payable when a principal residence is sold. This rule has become a source of huge tax free gains for a whole generation which owned a house which has risen significantly in value.
Tax experts (and Department of Finance officials) have had to come to grips with myriad situations where the exemption should be available but where the residence in question is either not lived in by the owner or may not be a conventional house. On the whole, the rule granting the exemption has been generously construed and from time to time there have been amendments to the Income Tax Act to ensure that the exemption is available.
A recent CRA letter shows how broadly the exemption is interpreted and also recognizes that family arrangements for the use of a house don’t always fall into any sort of standard format. In this case, somebody wrote to query a situation where a mother planned to transfer her house to a personal trust with one daughter having the right to live in it until her death upon which her siblings would be entitled to the remainder of the trust property.
While the letter didn’t spell out the family situation, one can infer that the mother was moving out of the family home (perhaps to a retirement home), wanted to ensure that her daughter had a place to live for the rest of her life but also ensure that all her children shared in the proceeds of the ultimate sale of the house. One brother asked whether the principal residence exemption would be available to the personal trust for the years during which his sister will inhabit the house. In other words, when the house was ultimately sold and the gain distributed upon his sister’s death, would there be any capital gains tax? If a personal trust sells a property, the tax consequences will depend, among other things, on whether that property is a principal residence.
Generally, a principal residence of a personal trust is a property that is ordinarily inhabited by a specified beneficiary of the trust, or by the spouse or former spouse, or by a child of the specified beneficiary. If the property qualifies as the personal trust’s principal residence for one or more tax years in which the personal trust owned the property, the personal trust may use the principal residence exemption to reduce or eliminate any capital gain that must otherwise be included in the personal trust’s income.
In order to qualify as a specified beneficiary for the principal residence exemption, a person must, among other things, be “beneficially interested” in the trust. Generally, a beneficially interested person has a right as a beneficiary under a trust to receive income or capital of the trust, and may include a person who has the right to reside rent-free in a housing unit owned by the trust. Therefore, the sister may be beneficially interested in the trust, depending on how the trust will be structured. Also, she could qualify as a specified beneficiary if she will ordinarily inhabit the housing unit.
In plain English, the principal residence exemption would likely apply in this case. Paragraph 35 of Interpretation Bulletin IT-120R6 contains more details about the principal residence exemption available to a personal trust.
While the letter in question does not actually get into tax planning, it is clear that an opportunity to maximize the exemption is available with proper planning and with the execution of the proper documentation.