Canada: Significant Changes To The Canadian Principal Residence Deduction

Last Updated: October 6 2016
Article by Kim G.C. Moody

Oh, give me a home where the buffalo roam
Where the deer and the antelope play;
Where seldom is heard a discouraging word,
And the sky is not cloudy all day
[unless the home is in a Canadian trust]

Many of us are familiar with the above opening words of "Home on the Range" – a classic western folk song that has its roots in the early 1870s. "Home on the Range" is a sentimental song that waxes about the longings and importance of a person's home. With that in mind, the Department of Finance released a series of measures on October 3, 2016, aimed at "...protecting the financial security of Canadians, supporting the long-term stability of the housing market and improving the integrity and fairness of the tax system, including ensuring the principal residence exemption is available only in appropriate cases." The measures released included changes to the mortgage default insurance rules for lenders and the announcement of a public consultation to "seek information and feedback on how modifying the distribution of risk in the housing finance framework by introducing a modest level of lender risk sharing for government-backed insured mortgages could enhance the current system." Details on the public consultation should be available shortly with the release of a public consultation paper by the Department of Finance. With British Columbia recently introducing a new tax on foreign purchasers for the Vancouver area, yesterday's announcement by the federal government is likely part of a continuing series of overall amendments that Canadian governments will make to ensure the stability of Canada's housing market. Home on the Range.

Before discussing the changes to the income tax regime, let's first discuss some basics. First, it is well known that Canadian resident individuals who dispose of their principal residence and realize an economic gain may claim an exemption when computing the taxable amount of their gain. The income tax exemption is contained in paragraph 40(2)(b) of the Income Tax Act (Act) and relies on a formula contained therein. The formula requires a taxpayer to compute the eligible amount of the gain that is exempt from taxation and is only applicable if the individual disposes of a property that was the individual's "principal residence". The formula also requires a proration for the number of years during which the property was the taxpayer's principal residence and the taxpayer was resident in Canada as compared to the total number of years that the taxpayer owned the property (jointly or otherwise with another person). In order to accommodate years where a taxpayer disposes of an old property and acquires a new property in the same year, the formula automatically adds '1' to the "principal residence" years – commonly known as the "1+ rule".

Second, the principal residence exemption in paragraph 40(2)(b) relies on the definition of "principal residence" in section 54 of the Act. The definition is very long and complex. This surprises the average Canadian since conceptually the understanding of a principal residence is easy to understand: "It's my house!" Oh, if tax law was only that simple. The definition contains nuanced requirements that require the taxpayer (or the spouse or common-law partner or child of the taxpayer) to have "ordinarily inhabited" the property with no such definition of what that phrase means. One has to look to the courts to determine what is meant by "ordinarily inhabited". The property also has to be a "capital property" of the taxpayer. Accordingly, "house flippers" are not eligible for the principal residence exemption since properties that are quickly sold after the acquisition will likely not be considered capital property but rather inventory. Any resulting profits would be considered business income that would not be entitled to the principal residence exemption and would be fully taxed rather than only 50 per cent taxable as a capital gain. The definition of principal residence also contains a size restriction on the immediately contiguous land to the housing unit (not to exceed a half hectare unless the taxpayer can establish that any excess was necessary for the use and enjoyment of such property – the courts are littered with cases where the taxpayer has argued that the excess land is necessary for the use and enjoyment of the property). In addition, the definition of principal residence in section 54 contains detailed rules (in paragraph c.1) that prohibits a trust (which is considered to be an individual for income tax purposes pursuant to the rule in subsection 104(2) of the Act) from considering a property as its principal residence unless very specific conditions are met. Simplified, such conditions require that no corporation be a beneficiary of the trust and the trust must designate in prescribed form each individual – a "specified beneficiary" – who is a beneficiary of the trust and ordinarily inhabited the property (or the beneficiary's spouse or common-law partner or child ordinarily inhabited the property). In addition, the trust must be a "personal trust" as defined in subsection 248(1) of the Act.

Third, the principal residence exemption under paragraph 40(2)(b) has been the subject of significant change over the years. One of the more significant changes occurred in 1982 when spouses could no longer each claim a principal residence exemption which enabled a "double-up" of the principal residence exemption. For years after 1981, spouses must, in effect, share the principal residence exemption.

Fourth, properties do not need to be Canadian properties to be considered principal residences as long as all of the other conditions are met in the definition of principal residence.

Fifth, the principal residence exemption as provided for in paragraph 40(2)(b) in conjunction with paragraph (c) [for individuals] and paragraph (c.1) [for trusts] of the definition of principal residence in section 54 of the Act requires the taxpayer to file a prescribed form – Form T2091 for individuals and Form 1079 for trusts. However, the Canada Revenue Agency's (CRA) longstanding administrative position was that prescribed form T2091 was not required to be filed for individuals if the principal residence exemption eliminated all of the taxable gain. The CRA did not provide similar administrative relief for trusts.

With the above background in mind, the Department of Finance proposed the following income tax amendments:

1. Changes to the "1+ Rule" in Paragraph 40(2)(b) of the Act

An individual who was a non-resident of Canada in the year of the acquisition of the principal residence property will no longer be able to automatically add "1" to the number of "principal residence" years in the calculation of the proration as discussed above. This new rule applies for dispositions after October 3, 2016. In effect, this will prevent a non-resident of Canada from being able to dilute their taxable capital gain on the disposition of an otherwise principal residence in years where they acquire and dispose of properties. In my opinion, this amendment makes sense from a policy perspective. However, will we now see non-residents gifting funds to their resident spouse or child to acquire the property and thus be able to continue to take advantage of the "1+ rule"? Likely.

2. Restrictions on the Use of the Principal Residence Exemption for Trusts

As discussed above, paragraph (c.1) of the definition of principal residence in section 54 of the Act enables a trust, in effect, to claim the principal residence exemption if very specific conditions are met. However, the Department of Finance proposes to add new conditions to paragraph (c.1). Essentially, such conditions will eliminate all "vanilla" personal trusts from being able to designate a property as its principal residence unless such trust is:

  1. An alter ego trust, joint spousal or common-law partner trust, spousal or common-law partner trust, or trusts that are commonly referred to as "self-benefit" trusts;
  2. A testamentary trust that is considered a "qualified disability trust"; or
  3. An intervivos or testamentary trust the settlor of which died before the start of the year with an eligible beneficiary being a Canadian resident minor child of the settlor.

While the carve-outs for (a) – (c) above are beyond the scope of this blog, suffice it to say that many trusts who hold principal residence properties will be affected by this change. It is very common to have a carefully crafted trust hold personal-use properties that could be considered principal residence properties. Such trusts are often used to effectuate better succession of properties to desired beneficiaries, avoid succession duties and avoid the application of certain dependent relief legislation that otherwise might be applicable or available to a person who might feel disenfranchised. While trusts may still have a place in family estate planning to hold principal residences, one will need to be very careful and cognizant of the new restrictions and consider using one of the above trusts referred to in (a) – (c) above if appropriate.

Canadians who are not United States (US) citizens or residents of the US often acquire US vacation property. Such property may be considered a principal residence of the individual under Canadian law if all of the other requirements of the definition of a principal residence are met. Often, but not always, it is advisable for these Canadians to acquire such property through a carefully crafted Canadian trust so as to provide efficient US income tax results upon sale and avoid US estate tax upon death. With the above amendments, most trusts that have been utilized to acquire such properties will be affected. However, in most cases, because the US does not have a principal residence exemption for non-US citizens or non-residents and because the US tax will tax the gains on sale it will not usually be advisable for such trusts to attempt to designate such property as a principal residence. Accordingly, for such trusts, the amendments announced by the Department of Finance should have no real impact on the overall planning. One exception would be if there were not a taxable gain from a US perspective but a gain from a Canadian perspective (likely because of foreign currency fluctuation). Of course, this should be reviewed on a case-by-case basis.

Families that have utilized trusts to hold principal residences will need to carefully review the amendments and make any necessary changes to ensure that their estate planning is still appropriate. Non-residents who utilized trusts to acquire property and claim the principal residence exemption will be greatly affected. Our firm has previously discussed the use of trusts with non-residents to acquire principal residences, but such planning is now effectively dead.

The trust amendments apply for trust dispositions of property in (or after) the trust's first taxation year that begins after 2016. If a trust owned the principal residence property before 2017, the new rules do not apply in determining whether the property may be designated as a principal residence of the trust for taxation years that begins before 2017. Ultimately, this means that affected trusts that currently own a principal residence property will no longer be able to add the number of years in the proration formula in paragraph 40(2)(b) for years of ownership after 2016.

3. Extended Reassessment Period

The rules for when the CRA may reassess a taxation year are laid out in section 152 of the Act. Overly simplified, the "normal reassessment period" for an individual is three years after the day of sending of an original notice of assessment by the CRA for a particular taxation year. However, subsection 152(4) sets out conditions where the Minister can reassess beyond the normal reassessment period. The Department of Finance is proposing to add paragraph (b.3) to subsection 152(4) to add a set of conditions that, if met, will enable the CRA to reassess tax beyond the normal three-year period. Simplified, if the taxpayer does not report a disposition of real property in a taxation year, the CRA may reassess for tax for an unlimited period beyond the normal reassessment period. In other words, the statute barred clock will never start ticking. Fortunately, companion amendments to subsection 152(4.01) will limit the Minister to reassess for only the unreported disposition of the real property.

What about taxpayers who dispose of their principal residence and have no tax liability and intend to rely on the CRA's old administrative position that form T2091 did not need to be filed to report the disposition? Well, see below.

4. Changes to CRA's Administrative Position for Reportings of Principal Residence Dispositions

Concurrent with the Department of Finance's announcement, the CRA announced significant changes to its administrative position regarding the reporting of principal residence dispositions. Briefly, the CRA states the following:

Starting with the 2016 tax year, individuals who sell their principal residence will have to report the sale on Schedule 3, Capital Gains of the T1 Income Tax and Benefit Return. Reporting will be required for sales that occur on or after January 1, 2016.

You will complete Schedule 3 and file it with your T1 Income Tax and Benefit Return for the year you sell the property. If the property was your principal residence for every year that you owned it, you will make the principal residence designation in your Schedule 3. In this case, the year of acquisition, proceeds of disposition and the description of the property are the information that will have to be reported. Schedule 3 will be modified accordingly. Form T2091 (or Form T1255) will still be required for the designation in the case the property was not your principal residence for all of the years that you owned it.

Significant changes! You will want to ensure that such dispositions together with all necessary disclosures are reported to ensure that the extended reassessment period as discussed in #3 above will not apply! Accountants/tax preparers get ready for more work!

Overall, the above changes are very significant. Affected taxpayers – and there are many – should take note and adjust course accordingly. "Home on the Range" states: [Home]... where seldom is heard a discouraging word. Well, the Department of Finance has released some discouraging words that will take some time for tax practitioners and estate planners to absorb. We'll stay positive though and encourage you to do the same.

Moodys Gartner Tax Law is only about tax. It is not an add-on service, it is our singular focus. Our Canadian and US lawyers and Chartered Accountants work together to develop effective tax strategies that get results, for individuals and corporate clients with interests in Canada, the US or both. Our strengths lie in Canadian and US cross-border tax advisory services, estateplanning, and tax litigation/dispute resolution. We identify areas of risk and opportunity, and create plans that yield the right balance of protection, optimization and compliance for each of our clients' special circumstances.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

Similar Articles
Relevancy Powered by MondaqAI
Collins Barrow National Incorporated
In association with
Practice Guides
by Mondaq Advice Centres
Relevancy Powered by MondaqAI
Related Topics
Similar Articles
Relevancy Powered by MondaqAI
Collins Barrow National Incorporated
Related Articles
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of

To Use you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions