Effective January 1, 2017, the kinds of trusts that can claim the Principal Residence Exemption (PRE) will be limited. Now, the PRE allows Canadian resident taxpayers and personal trusts to reduce or eliminate a realized capital gain and the associated tax on the sale of a principal residence. But after December 31, 2016, amendments to the Income Tax Act (Canada) kick in and only certain kinds of trusts will be able to claim the PRE – and many trusts could face unanticipated capital gains taxes on the sale of a principal residence.
Trusts that hold a principal residence as a trust asset, but no longer qualify for the PRE shouldn’t, however, hand over the keys just yet. Here’s the problem with trusts claiming the PRE starting January 1, 2017 and a possible solution to the problem.
The PRE Problem. A common estate planning and asset protection technique is to set up a trust to hold a personal residence; the trust then claims the PRE. However, as of January 1, 2017, only certain types of trusts will qualify to claim the PRE:
As a result, many “asset protection” trusts that are holding a principal residence will no longer qualify to claim the PRE – and any gains these asset protection trusts realize on the sale of the property they hold may not be sheltered. Other trusts that will be negatively impacted include inter-vivos trusts for disabled adult children, inter-vivos or testamentary trusts for capable adult children and qualified disability trusts (QDTs) that own a residence and were settled by a person other than the beneficiary’s spouse or common-law spouse.
An affected trust that owns a property at end of 2016 and disposes of it after 2016 can, however, still use the PRE, but only to shelter the portion of any gains that accrued up to December 31, 2016. So it will be important to know the residence’s value on December 31, 2016. Any trust eligible for the PRE under the new rules that acquired property after the October 3, 2016 (the date on which the government announced these PRE changes) must include terms that give the eligible beneficiary a right to use and enjoy
the property as a residence.
A PRE Solution. Despite this change, a trust that no longer qualifies for the PRE should avoid selling the residence after 2016, if possible. A sale of the residence from the trust or a roll-out to a qualifying beneficiary before the end of 2016 are possible solutions. However, at any time after the end of 2016, the trustees can still use the trust to hold the residence, and at a later date, roll the residence out to a qualifying beneficiary. When the residence is ultimately sold post 2016, that beneficiary, if otherwise eligible, can then claim the PRE for all the years the trust owned the residence. Subsection 107(4.1)(a.1) of the Act now allows such trusts to roll-out to a qualified beneficiary the principal residence that the trust owned at the end of 2016. To qualify as a beneficiary for this roll-out, the beneficiary must be: a resident in Canada for the year in which they are claiming the PRE, and one of the settlor of the trust, the settlor’s spouse or child. The trust can still elect to transfer the property out of the trust at fair market value under section 107(2.001) of the Act. While this is a solution for many trusts that no longer qualify for the PRE as of 2017, there are circumstances where the roll-out may not be possible – so be sure to first contact your legal advisor for advice with respect to any trust that holds a principal residence.
To discuss this or any other legal issue, contact any member of McInnes Cooper’s Estates & Trusts Law or Tax Law Team. Read more McInnes Cooper Legal Publications and subscribe to receive those relevant to your business.
McInnes Cooper prepared this article for information; it is not legal advice. Consult McInnes Cooper before acting on it. McInnes Cooper excludes all liability for anything contained in or any use of this article. © McInnes Cooper, 2016. All rights reserved.
About the author:
Sarah Dykema is an Estates & Trusts lawyer at McInnes Cooper and holds STEP Canada’s prestigious Trust and Estate Practitioner (TEP) designation. Sarah advises clients on domestic and cross-border trust and estate planning and administration, incapacity and probate planning, estate administration and drafts wills and powers of attorney geared to minimize tax implications on death. You can reach Sarah at email@example.com.