CRA finds that a deemed s. 248(3) testamentary usufruct trust might access the principal residence exemption on the spousal usufructuary’s death or on her surrendering her interest

A housing unit is subject to a usufruct created by the Quebec will of Mr. X, with Mr. X’s surviving spouse (Ms. X) being the usufructuary, and their child being the bare owner. Ms. X ordinarily inhabits the housing unit.

The creation of the usufruct would create a deemed (testamentary) trust under s. 248(3), which would qualify as a spousal trust for purposes of a s. 70(6) rollover to such trust of the residence assuming that, under the terms of the will, no person other than Ms. X would be entitled during her lifetime to receive or otherwise obtain the use of any part of the income or capital of the trust.

CRA indicated that the death of the usufructuary (Ms. X) would terminate the usufruct and the deemed trust, which would imply the distribution of the housing unit to the bare owner. Upon the termination of the deemed trust, since the distribution of the property by the deemed trust (referred to in s. 104(4)(a)(i)), would be made to a beneficiary other than the surviving spouse, s. 107(4) would apply to the distribution, so that s. 107(2.1) would result in realization of a capital gain by the deemed trust. However, as Ms. X would be beneficially interested in the deemed trust under s. 248(3)(d), she could be considered a specified beneficiary as defined in s. (c.1)(ii) of the "principal residence" definition to the extent that she ordinarily inhabited the residence during the years the deemed trust owned it by virtue of s. 248(3) – thereby allowing the deemed trust to designate the residence as its principal residence, provided that all the other conditions of the "principal residence" definition were satisfied.

Regarding what would be the consequences of Ms. X surrendering her usufruct, CRA noted that such surrender would terminate the deemed trust and result in the distribution of the deemed trust’s property to the bare owner. Ss. 107(2.1) and (4) would apply to this distribution. However, again, the deemed trust could claim the principal residence exemption provided the usual conditions were satisfied.

In another variation, if the usufruct for Ms. X (following Mr. X's death) was for specific term of years, there thus would be a potential for someone other than the surviving spouse to receive or obtain the use of part of the income or capital of the deemed trust during the lifetime of the spouse (Ms. X), so that the condition in s. 70(6)(b)(ii) would not be met, and there would be no spousal rollover on Mr. X’s death.

Finally, what if the bare owner (the child) assigned her bare ownership interest in the residence to her mother, the usufructuary (Ms X), or predeceased her mother? CRA indicated that, pursuant to s. 70(5) or 69(1)(b), the bare owner would be deemed to have received the FMV of the capital interest in the deemed trust on its deemed disposition on the death, or on its assignment to the usufructuary, respectively. Moreover, the assignment to the usufructuary would cause the deemed trust’s termination, so that the housing unit would be distributed to the usufructuary on a rollover basis pursuant to s. 107(2).

Neal Armstrong. Summaries of 7 October 2020 APFF Roundtable Q. 5, 2020-0852171C6 F under s. 54 - principal residence – (c.1), s. 107(4), s. 70(6)(b)(ii) and s. 248(3).

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