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.

Kim G C Moody
In association with
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). 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 & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd 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 or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at and we will use commercially reasonable efforts to determine and correct the problem promptly.