New capital gains rules for trusts owning a principal residence

Fundata

Last year, the federal government made some key changes to the principal residence exemption (PRE) rules by closing loopholes surrounding the capital gains exemption” as they relate to the sale of your home. Here’s a look at the nitty gritty of the changes related to ownership of a principal residence by a trust.

Under the new rules, additional requirements were introduced where a trust owns a principal residence (for the years that begin after 2016). Essentially, only the following types of trusts are able to designate a principal residence (where the trust has a “specified beneficiary” who is a resident of Canada during the year(s) for which the PRE is being claimed):

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* An alter ego trust, spousal or common-law partner trust, joint spousal or common-law partner trust, or a similar trust for the exclusive benefit of the settlor of the trust during his/her lifetime;

* A testamentary trust created under a will that is a qualifying disability trust for which the beneficiary is a spouse, common law partner, former spouse, former common law partner, or child; or

* A trust for the benefit of a minor child of deceased parents.

If you have a trust that owns a principal residence and does not meet the above conditions, you can take advantage of transitional rules that will allow the trust to crystallize the PRE for any accrued capital gain relating to the property up to Dec. 31, 2016.

Essentially the trust will be deemed to have disposed of the property on Dec. 31, 2016 (the trust can shelter the gain under the PRE up until that date) and to have reacquired the property at a cost equal to the fair market value on Jan. 1, 2017. However, you may want to reconsider keeping the property in the trust for years after 2017, since it will no longer be sheltered (whereas it can be sheltered if owned directly by a beneficiary).

The new rules allow a trust that does not qualify for the PRE to make a tax-deferred distribution of the property to the beneficiary who had ordinarily occupied the property (assuming the beneficiary has a capital entitlement to the trust) and, for the purposes of accessing the PRE, the beneficiary will be able to designate the property as his or her principal residence for those years it was owned by the trust.

If the beneficiary who had ordinarily occupied the property does not have a capital entitlement to the trust such that the property cannot be distributed out to him or her, it may still be possible for the beneficiary to take advantage of the PRE after 2016 if there is another way for the beneficiary to become the beneficial owner of the property.

For example, the property could be distributed to a capital beneficiary of the trust at fair market value (but this means that tax will be owing in the trust to the extent of any increase in value of the property from Jan. 1, 2017, to the date of the distribution). The capital beneficiary in turn gifts the property to the first-mentioned beneficiary (who ordinarily occupies the property), who will then be able to designate the property as his or her principal residence for the tax years after the gift is made.

Trusts are often used to hold a principal residence as part of a succession and/or estate plan and as such, the planning we describe above might not be appropriate in a number of situations; for example, where the beneficiary is not equipped to control material wealth or where the property was originally intended to be transferred to other beneficiaries.

If you kept the principal residence in a trust, any planning intended to sidestep or mitigate the impact of the new rules should be carefully reviewed by you and your advisors to ensure your original planning goals are still being achieved. Furthermore, in considering such planning, you should be mindful of any applicable land transfer tax, and structure the distribution from the trust to ensure such tax is avoided or mitigated.

Courtesy Fundata Canada Inc. © 2017. Samantha Prasad, LL.B. is Tax Partner and Ryan Chua is an Associate with Toronto law firm Minden Gross LLP. Portions of this article appeared in The Minden BriefWinter 2017, published by Minden Gross LLP. Used with permission.

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