Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.
Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CCRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.
XXXXXXXXXX 2002-012668
Annemarie Humenuk
June 18, 2002
Dear XXXXXXXXXX:
Re: Principal Residence Designation and an Alter Ego Trust
This is in reply to your letter received on March 5, 2002 concerning the rules applicable to an alter ego trust and the principal residence designation.
Paragraphs 35 and 36 of Interpretation Bulletin IT-120R5, Principal Residence, discuss some of the significant aspects of the rules concerning the principal residence designation available to a personal trust. An inter vivos personal trust is a trust under which no beneficial interest was acquired for consideration payable directly or indirectly to the trust or to any person who made a contribution to the trust by way of transfer, assignment or any other disposition of property. For this purpose, the settlor of a trust who also has an interest in that trust is not considered to have acquired an interest in the trust for consideration solely because of his or her transfer of property to the trust. As a result, an alter ego trust, like a spousal trust, would presumably be a personal trust. You have asked several questions relating to the designation of a principal residence by an alter ego trust. You also ask for our comments on an example you prepared which is similar to the example found in paragraph 35 of the bulletin.
With respect to some of the questions posed in your correspondence, it is not our role to engage in tax planning. Accordingly, you may wish to seek professional tax advice with respect to the tax planning aspects of questions raised in your letter. Written confirmation of the tax consequences of a particular transaction is given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R5. Where the particular transactions are completed, all relevant facts and documentation should be submitted to the appropriate taxation services office for their views. It should also be noted that the Canada Customs and Revenue Agency needs the appropriate authorization from the taxpayers who are the subject of the enquiry in order to discuss their tax affairs with another person. However, we hope the following general comments will be of assistance to you.
All statutory references in this letter are to the Income Tax Act.
You ask whether the rules described in IT-120R5 apply to a deemed disposition of property under subsection 70(5) as well as to an actual disposition or sale of such property. The designation of a property as a principal residence by an individual will reduce the capital gain on that property whether the capital gain is realized as a result of an actual or deemed disposition of that property.
You ask us to confirm that the rules which result in a deemed disposition of a trust's property every 21 years would only apply to an alter ego trust if that trust continues beyond the death of the settlor. Normally, the first deemed disposition under subsection 104(4) for an alter ego trust occurs at the end of the day on which the settlor dies. As the next deemed disposition under subsection 104(4) for such a trust would typically occur on the day that is 21 years after the day on which the settlor died, a trust that is wound up before that date would not normally be subject to a second deemed disposition under subsection 104(4). A deemed disposition of the property of an alter ego trust under subsection 104(4) may also arise in certain circumstances where it is reasonable to conclude that certain transactions were undertaken to avoid the tax that would otherwise have been payable as a result of a deemed disposition under subsection 104(4) or as a result of the settlor ceasing to be resident in Canada. In addition, the trustee of an alter ego trust may make an election in the first year of the trust to have the first deemed disposition under subsection 104(4) occur on the day that is 21 years after the creation of the trust rather than on the day the settlor dies, in which case the settlor of the trust would not be entitled to the rollover under subsection 73(1) in respect of the property transferred to the trust.
When property is distributed to a beneficiary out of a personal trust, including an alter ego trust, in satisfaction of all or part of a beneficiary's capital interest in the trust, the general rule is that the trust is deemed to have disposed of the property at its cost and the beneficiary is deemed to have acquired the property for the same amount. As stated in paragraph 35 of IT-120R5, when the property being distributed could have been designated as the trust's principal residence for any taxation year in which it was owned by the trust, an election is available under subsection 107(2.01) under which the trust is deemed to have disposed of the property at its fair market value at that time and reacquired it immediately before the distribution for the same amount. As a result of such an election, the beneficiary acquires the property at its fair market value and any accrued capital gain on the property is recognized in the trust, taking into account the formula for the reduction of the capital gain for the period in which the property was designated as the trust's principal residence.
You ask whether the election under subsection 107(2.01) is available to an alter ego trust as well to a spousal trust. In this regard, you note that page 28 of the 2001 T3 Guide suggests that the election under subsection 107(2.01) is only available to an alter ego trust where the property is distributed to the settlor. As noted above, the election under subsection 107(2.01) is available to all personal trusts, including an alter ego trust and a spousal trust, where the trust owns property which could have been designated as the trust's principal residence for any year in which the trust owned the property. While the election under subsection 107(2.01) is potentially available on the distribution of property to a beneficiary following the death of the settlor of an alter ego trust, it would normally have minimal effect since the alter ego trust would have realized a deemed disposition on the death of the settlor, the gain on which would have been reduced based on the number of years in which the property was designated or deemed to have been designated as the principal residence of the trust up to that time. Any claim for a principal residence exemption in respect of the subsequent disposition is based on the number of years following the deemed disposition on the settlor's death in which the property was designated as the trust's principal residence. It should be noted that even if a particular trust is not entitled to make an election under subsection 107(2.01), a personal trust that is resident in Canada can elect out of the application of subsection 107(2) by means of the election described in subsection 107(2.001).
Paragraph 36 of IT-120R5 explains the effect of subsection 40(4) on the calculation of the exempt portion of the capital gain arising on the disposition of a property which has been acquired from another taxpayer on a rollover basis under either subsection 73(1) or 70(6) and which is designated as the principal residence of the recipient on a subsequent disposition. You ask whether this rule applies to both inter vivos and testamentary trusts, and in particular, whether it applies to alter ego trusts. Subsection 40(4) can apply to both inter vivos and testamentary trusts. When property is acquired by a spousal trust, a joint spousal or common-law partner trust or an alter ego trust on a rollover basis (either under subsection 73(1) in the case of an inter vivos trust or under subsection 70(6) in the case of a testamentary spousal trust), the trust is deemed to have owned the property throughout the period in which the settlor owned the property. As an alter ego trust is, by definition, an inter vivos trust, property received by an alter ego trust on a rollover basis under subsection 73(1) is deemed to be the principal residence of that alter ego trust for any taxation year in which it was in fact the settlor's principal residence. The main difference between the application of subsection 40(4) to property acquired by an inter vivos trust and to property acquired by a testamentary trust is that the property is deemed to be the principal residence of a testamentary trust for each year in which it was eligible to be the deceased person's principal residence and not just for each year in which it actually was the principal residence of the deceased.
You also asked us to comment on the following situation. For the purpose of this example, it is assumed that the property in question otherwise qualifies as the principal residence of the taxpayer (Mr. X) and his spouse (Mrs. X) and that neither of them owns any other property that could qualify as a principal residence. All references to designations refer to designations made in the prescribed form and manner.
Assumed Facts
? Mr. X owns and ordinarily inhabits a housing unit from 1983 until his death in 1993. As a result, the housing unit qualifies as his principal residence for each year that it was owned by him and any gain realized as a result of the operation of subsection 70(5)(a) on his death is excluded from income by reason of the formula in paragraph 40(2)(b).
? In 1988, Mr. X marries and his spouse occupies the property with him until her death in 2002.
? In 1991, Mr. X transfers 50% of the beneficial ownership of the property to his spouse and registers the title to the property under joint tenancy. Mr. X relies on subsection 73(1) such that his proceeds of disposition in respect of the disposition equal the adjusted cost base of the part of his interest in the property transferred to his spouse.
? In 1993, Mr. X dies. As a result of the operation of laws governing joint tenancy, Mrs. X owns 100% of the property. In accordance with paragraph 70(5)(b) of the Act, she acquires her spouse's 50% interest in the property at the deemed proceeds under paragraph 70(5)(a) of the Act. For this purpose, it is assumed that the executor of Mr. X's estate has opted out of the rollover provisions of subsection 70(6) and has designated the property as Mr. X's principal residence for each year in which he owned it (1983-1993).
? In 2000, Mrs. X transfers her interest in the property to an alter ego trust, relying on subsection 73(1) such that her proceeds of disposition in respect of the property equal her adjusted cost base.
? In 2002, Mrs. X dies and a deemed disposition is realized by the alter ego trust under subsection 104(4).
? In 2004, the property is distributed from the alter ego trust to the adult son of Mr. X.
You ask us to comment on the deemed dispositions realized by the alter ego trust on the death of Mrs. X and on the distribution of the property to the adult son.
As a result of the application of subsection 40(4), Mrs. X is deemed to have owned her interest in the property from 1983 to 1991 for the purpose of calculating the exempt portion of the gain since she acquired her interest on a rollover basis under subsection 73(1). In addition, the property is deemed to be her principal residence for 1983 to 1991 as it was designated as the principal residence of Mr. X for each of those years.
Notwithstanding the fact that no gain arises on the transfer of the property to the alter ego trust as a result of the operation of subsection 73(1), Mrs. X may also designate the property as her principal residence for any of the 1992-2000 taxation years.
As a result of the application of subsection 40(4), the alter ego trust is deemed to have owned the property from 1983 to 2000 for the purpose of calculating the exempt portion of the gain since it acquired the property on a rollover basis under subsection 73(1). In addition, the property is deemed to be the principal residence of the alter ego trust from 1983 to 1991 as it was deemed to be the principal residence of Mrs. X during that time. Provided that Mrs. X also designates the property as her principal residence for the 1992 to 2000 taxation years, subsection 40(4) will deem the property to be the principal residence of the alter ego trust for each of those years as well.
For any taxation year between 2000-2004 in which a specified beneficiary of the alter ego trust occupied the property, the trust may designate the property as its principal residence for that particular year or years. The trust will realize a deemed disposition under subsection 104(4) upon the death of Mrs. X in 2002. Provided that the number of years in which the property was either owned or deemed to be owned by the trust at the time of the disposition is not more than one year more than the total number of years in which the property is either deemed to be the trust's principal residence under subsection 40(4) or is designated as such by the trust, the gain from that disposition will be fully exempt.
When the property is distributed to the beneficiary in 2004, subsection 107(2) will apply to deem the trust to have disposed of the property at its adjusted cost base (i.e., the deemed cost of acquisition as a result of the application of subsection 104(4) on the death of Mrs. X), unless the trustee makes an election under subsection 107(2.01) or 107(2.001). The effect of either of these elections is that the trust is deemed to have disposed of the property at its fair market value at that time and the beneficiary is deemed to have acquired the property at that same value. This would result in any gain or loss in the fair market value of the property from the date of Mrs. X's death being taxed in the alter ego trust, recognizing that any gain would be reduced based on the formula described in paragraph 7 of the bulletin if the alter ego trust designates the property as its principal residence for any of the 2002-2004 taxation years.
As a final note, you asked who is required to file and sign the form designating a particular property to be the principal residence of a person who is deceased when the capital gain is realized as a result of the deemed disposition under subsection 70(5). As stated on page 5 of the 2001 version of T4011, Preparing Returns for Deceased Persons, the legal representative of the deceased person is responsible for filing the final tax return for the deceased as well as any other returns that have not been filed prior to the date of death. Where an executor has been appointed by will, the executor will normally be the legal representative of the deceased. As the legal representative, the executor is typically authorized to make whatever elections or designations are appropriate on behalf of the deceased. The appropriate form to be used by the executor to designate a property as a principal residence of the deceased person for the purpose of calculating the capital gain realized as a result of the deemed disposition on death is T2091 (IND), Designation of a Property as a Principal Residence by an Individual (Other than a Personal Trust), notwithstanding the fact that the executor is also responsible for filing T3 trust returns on behalf of the estate. If the principal residence designation is to be made in respect of the property for the period in which it is held by the estate or by any testamentary trust created as a consequence of that death, T1079, Designation of a Property as a Principal Residence by a Personal Trust, is the appropriate form to be filed with the T3 return for the year in which the disposition or deemed disposition occurs.
As indicated in paragraph 22 of Information Circular 70-6R5, this opinion is not an advance income tax ruling and consequently, is not binding on the Canada Customs and Revenue Agency.
T. Murphy
for Director
International and Trusts Division
Income Tax Rulings Directorate
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