Don’t Sell Yet: How Principal Residence Exemption (PRE) Changes Affect Trusts
Published:
December 22, 2016
Author(s):
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:
- A spousal or common-law partner trust.
- A joint spousal or common-law partner trust.
- An alter ego trust (or self-benefit trust).
- A qualifying disability trust.
- A trust for the benefit of a minor child of deceased parents.
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 the property after 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.
Please contact your McInnes Cooper lawyer or any member of the Tax Solutions or Estates & Trusts Planning Team @ McInnes Cooper to discuss this topic or any other legal issue.
McInnes Cooper has prepared this document for information only; it is not intended to be legal advice. You should consult McInnes Cooper about your unique circumstances before acting on this information. McInnes Cooper excludes all liability for anything contained in this document and any use you make of it.
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