Canada: New Principal Residence Exemption Rules
On October 3, 2016 the Federal Government proposed changes to the Income Tax Act (the “Act”) and administrative policies that will impact claiming the principal residence exemption.
1. All dispositions of principal residences must now be reported.
Previously, the CRA did not require taxpayers to report the sale of a principal residence when the principal residence exemption protected the full amount of the gain. However, for years that end after October 2, 2016 (i.e. including the 2016 taxation year), the CRA now requires an individual to report on Schedule 3 of their T1 income tax return the disposition of a property for which the principal residence exemption is claimed. The information required includes the address of the property, the date it was acquired and the amount of the proceeds of disposition. This reporting is necessary in order to claim the full principal residence exemption. Dispositions include deemed dispositions, for example when you change your residence to a rental property, and not just actual sales of the property.
Form T2091 (or Form T1255) will still also be required for the designation in the case the property was not your principal residence for all of the years that you owned it.
Failure to report the sale and designation of a principal residence will result in the principal residence exemption being disallowed – though the CRA may accept late filed elections in certain circumstances with a late filing penalty of the lesser of $8,000 or $100 per month for which it was overdue. If you disposed of your principal residence in 2016, make sure you report it in your 2016 income tax return.
2. The CRA will be able to reassess beyond the normal reassessment period when a disposition of real estate is not reported on the taxpayers return.
The Government has also changed the Act to extend the normal reassessment period for all taxpayers in respect of all real estate when the taxpayer fails to report the disposition of real property. Fortunately, the reassessments are limited only to the unreported disposition of the real property.
3. Only those who were residents of Canada during the year that includes the acquisition date will get the additional year of coverage of the principal residence exemption.
If you are a Canadian resident throughout the period you owned your principal residence, then this will not impact you. You will still be able to claim the principal residence exemption for one plus the number of taxation years that end after the acquisition date for which the property is your principal residence and during which you were a resident in Canada. However, on dispositions after October 2, 2016, the Government has changed that Act so if you acquired the property in a year you were not a resident of Canada you will no longer get the additional year.
4. The ability of a trust to claim the principal residence exemption is significantly reduced.
Prior to the recent changes, a trust could claim the principal residence exemption provided one of its beneficiaries lived in the property. However, the new rules now limit the types of trusts that can claim the principal residence exemption to the following:
- Alter ego trusts
- Spousal/common-law partner trusts
- Joint spousal or common-law partner trusts
- A trust where the property is transferred into the trust by the beneficiary and there is no change in the beneficial interest of the property
- A qualified disability trust
A trust where the settlor died before the start of the year and the eligible beneficiary or beneficiaries must be the minor child of the settlor whose parents are deceased before the end of the year (i.e. an orphan trust)
Many trusts will no longer qualify. If you are involved with a trust where it is desirable that the principal residence exemption be claimed we recommend you review the trust and potentially consider whether the principal residence should be transferred out of the trust
