On October 3, 2016, Finance Minster Morneau announced changes to the principal residence exemption which will in some circumstances create hardship for beneficiaries of trusts. The principal residence exemption allows you to shelter your principal residence from capital gains on the sale, provided you and the residence meet the necessary criteria under the Income Tax Act, Canada.
The change to the principal residence exemption that has garnered the most publicity, and which does not particularly concern me, is the requirement that the sale of a principal residence be reported on the seller’s tax return.
The changes that do concern me from an estate-planning perspective are the new restrictions on the ability to claim the principal residence exemption in a trust where a beneficiary is using the residence as a principal residence. It will only be available in certain circumstances for certain kinds of trusts, such as an alter ego or joint partner trust, a testamentary trust that qualifies as a disability trust for a disabled beneficiary, and a trust created for a minor child if both of the minor child’s parents have died.
Here is part of the explanatory notes from the Department of Finance:
In the case where the taxpayer is a personal trust, a property does not qualify as the trust's principal residence for a taxation year unless the requirements in paragraph (c.1) of the definition are met. That paragraph includes the requirements that the trust designate, in prescribed form, the property as the trust's principal residence for the taxation year and that the designation identify each individual who in the taxation year is a specified beneficiary of the trust for the year. For this purpose, a specified beneficiary of a trust for a taxation year is an individual who in the taxation year is beneficially interested in the trust and who (or whose spouse or common-law partner, former spouse or common-law partner or child) ordinarily inhabits the housing unit in the taxation year.
Paragraph (c.1) is amended to introduce additional requirements in order for a property to qualify as a trust's principal residence for a taxation year that begins after 2016. In general terms, these requirements are that the trust be an eligible trust one of whose beneficiaries (the "eligible beneficiary") is resident in Canada in the year and a specified beneficiary of the trust for the year. In addition, where the trust acquires the property on or after Announcement Date, the trust's terms must provide the eligible beneficiary with a right to use and enjoy the housing unit as a residence throughout the period in the year that the trust owns the property. Eligible trusts fall into three categories, although a trust may qualify as an eligible trust under more than one of the categories:
In the first case, an eligible trust is an alter ego trust, spousal or common-law partner trust, joint spousal or common-law partner trust, or certain trusts for the exclusive benefit of the settlor during the settlor's lifetime. In this case, the eligible beneficiary is the individual whose death (at any time after the start of the year) determines a day for the trust under subsection 104(4). In effect, the eligible beneficiary must be, depending upon the type of trust, the trust's settlor, or the spouse or common-law partner or former spouse or common-law partner of the settlor. A joint spousal or common-law partner trust may have more than one eligible beneficiary for a taxation year.
In the second case, an eligible trust is a testamentary trust that is a qualified disability trust for the taxation year. In this case, the trust's eligible beneficiary must be an electing beneficiary under the trust for the year who is a spouse or common-law partner, former spouse or common-law partner or a child of the trust's settlor. The trust may have more than one eligible beneficiary for a taxation year.
In the final case, an eligible trust is a trust (inter vivos or testamentary) the settlor of which died before the start of the year. In this case, the eligible beneficiary must be a minor child of the settlor whose parents (i.e., the settlor and the other parent) are deceased before the start of the year. The trust may have more than one eligible beneficiary for a taxation year.
Here are a few examples of situations where the trust will not be able to claim a principal residence exemption.
- A parent creates a trust during the parent’s lifetime for a child with a disability, and the trust holds the child’s residence. Because the trust is not testamentary (not created by a will, or otherwise arising as a consequence of the parent’s death), the residence will not be eligible for the principal residence exemption. Worst, because of the deemed disposition of assets in a trust every 21 years, the child could lose her residence if there are no other funds available to pay the tax.
- Even if a trust described above were created by a will, it might not qualify if there is another trust in respect of the child that has already been designated as a qualified disability trust.
- A parent creates a trust in his or her will for a child who has had drug addiction problems in order to provide for the child, but also protect the child in case of a relapse. The trustee purchases a residence for the child but holds it in the trust in order to retain control. The residence will not qualify for the principal residence exemption.
- A parent, who was divorce from the other parent, leaves her residence to her minor child. The other parent lives with the minor child in the residence, thereby allowing the child who has lost a parent to remain in the same home. The residence will not qualify.
As far as I am aware the Minister of Finance did not consult with estate-planning professional organizations. In previous posts, I criticized the Harper Government for some of its tax changes relating to estates and trusts, but it seems the assault on trusts, and good estate planning continue under the Liberal Government.