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.
Principal Issues: 1) Is it possible for each of two brothers, who co-own land which has two separate homes, to each claim the principal residence exemption pursuant to paragraph 40(2)(b) in respect of the home they occupy? 2) How does an election pursuant to subsection 45(2) by one of the brothers affect any principal residence exemption?
Position: 1) Yes 2) If a valid election is made, the taxpayer may designate the property as a principal residence for up to 4 years during which the election is in effect
Reasons: 1) The term housing unit mentioned in the definition of "principal residence" in section 54 has been broadly interpreted such that two units on the same property can be separate principal residences. 2) A valid election pursuant to subsection 45(2) deems there to be no change of use when a taxpayer converts a housing unit, that is his principal residence, into a rental property.
April 28, 2006
Vancouver Tax Services Office HEADQUARTERS
Mr. Kevin Diablo S. Lewis
Client Services Call Centre
9th Floor, Section 471-25
Central City Tower
C/o Surrey Tax Centre Mailroom
2005-015744
Principal Residence Exemption
This is in reply to your correspondence of November 4, 2005, concerning the principal residence exemption.
You have described a situation in which two brothers jointly own a property that has two self-contained residences. You are concerned with whether each brother is entitled to a principal residence exemption in respect of the home they occupied.
You have provided the following facts:
In XXXXXXXXXX the brothers jointly bought a XXXXXXXXXX acre (approximately XXXXXXXXXX hectares) property (Property) in the country for $XXXXXXXXXX.
There are two homes on the Property; however, the Property has only one address and is registered at the Land Titles registry as a single piece of property.
The Property was sold in XXXXXXXXXX for $XXXXXXXXXX.
From XXXXXXXXXX to XXXXXXXXXX Brother A lived in House A and considered it to be his principal residence.
From XXXXXXXXXX to XXXXXXXXXX Brother B lived in House B and considered it to be his principal residence.
In XXXXXXXXXX Brother B began renting out House B.
You are concerned with whether both Brother A and Brother B can claim their own principal residence exemption. You would also like to know about the application of subsection 45(2) of the Income Tax Act, R.S.C. 1985 (5th supplement).c.1 as amended (the "Act").
If a property is ordinarily inhabited and qualifies as a principal residence, an exemption may be claimed under paragraph 40(2)(b) of the Act to reduce or eliminate any capital gain that would be otherwise realized on the disposition of the property. This exemption may also be available for up to four years where the property is subsequently turned into a rental property if the taxpayer elects in the year of change in use pursuant to subsection 45(2) of the Act. Subsection 45(2) deems that there is no change in use of the property.
"Principal residence" is defined in section 54 of the Act. The definition includes, among other things, a property that is a housing unit that the individual (or certain family members) ordinarily inhabited in the year. Paragraph (e) of the definition of principal residence addresses how any land around the housing unit should be treated. In general, land of a 1/2 hectare or less is part of the principal residence. However, any portion in excess of the 1/2 hectare is deemed not to be part of the principal residence unless the taxpayer establishes that that portion was necessary for the use and enjoyment of the housing unit as a residence.
In general, a particular property can be considered an individual's principal residence for a taxation year, if the property:
- is a housing unit;
- is owned by the taxpayer (whether jointly with another person or otherwise);
- was ordinarily inhabited in the year by the taxpayer, the taxpayer's spouse, common-law partner, former spouse or common-law partner, or child; and
- is the only property designated by the taxpayer as the taxpayer's principal residence and no other property was so designated as the principal residence of any member of the taxpayer's family unit, as explained in paragraph 6 of IT-120R6.
In the facts provided, there are three outstanding issues, namely:
1) Is each house a separate housing unit?
2) Does the joint ownership of the property preclude a brother from claiming a principal residence exemption in respect of the full capital gain arising from the disposition of the unit that he designates as a principal residence?
3) Is land in excess of 1/2 hectare (the "Excess Land") necessary for the use and enjoyment of each housing unit as a residence?
The term housing unit is not defined in the Act; however the term has been broadly defined in jurisprudence and is discussed in IT-120R6. In particular, at paragraph 3, IT-120R6 states that a housing unit can include a house; an apartment or a unit in a duplex, apartment building, or a condominium; a cottage; a mobile home or a trailer. There is no requirement that two housing units be on separate legal lots in order that each may qualify as a principal residence.
With respect to the second issue ultimately it will come down to a question of fact whether or not the Excess Land is necessary for the use and enjoyment of the housing unit as a residence. The CRA position and the relevant factors for making such determination are set out in paragraphs 14 to 17 of IT-120R6. Nevertheless, we will make the observations that follow. The word "necessary", as defined in the Oxford English Dictionary, means "Indispensible, requisite, essential, needful; that cannot be done without".
As noted by the Federal Court of Appeal in Carlile v. The Queen, 95 DTC 5483, "A taxpayer who contends that an area in excess of a half hectare (one acre) [sic] of the subjacent land is his principal residence must prove its necessity. The burden is on him to establish that the excess is necessary to the use and enjoyment of the housing unit as a residence." As indicated in paragraph 15 of IT-120R6, generally the use of land in excess of 1/2 hectare in connection with a particular lifestyle (such as country living) does not mean that the excess land is necessary for the use and enjoyment of the housing unit as a residence.
Where a taxpayer was required by law or regulation to have a minimum size lot at the time of the disposition of the property, that size will generally be considered necessary, if the land was not used for income producing purposes (see for example The Queen v. Yates, 86 DTC 6296).
Excess land may be considered necessary if the location of the housing unit requires the excess land in order to provide its occupants with access to and from public roads.
In conclusion, in the situation you have described, the sole fact that House A and House B are situated on a single piece of land will not preclude Brother A and Brother B, from designating each respective home as their principal residence eligible for the exemption pursuant to paragraph 40(2)(b) which is discussed in paragraph 8 of IT-120R6.
Furthermore, unless the brothers could prove that land in excess of 1/2 hectare was necessary for the use and enjoyment of their respective housing units as a residence, the Excess Land would not be considered part of their principal residence.
With respect to application of the principal residence exemption, although each brother has an undivided interest in the property, in these circumstances, it would not be unreasonable to regard the full capital gain pertaining to a house as if it belonged entirely to the brother entitled to designate the house as a principal residence.
In a situation in which a principal residence is converted into a rental property, a taxpayer is required to make the election under subsection 45(2) in the year in which the property is first used as a rental property. Only the taxpayer whose respective housing unit is converted to rental property needs to file the election.
If the taxpayer failed to make the election under subsection 45(2), subsection 220(3.2) of the Act allows the taxpayer to apply to the Minister to allow the filing of a late election. IC-92-1 discusses the filing of late elections.
We trust these comments are of assistance.
S. Parnanzone
Manager
Business Incentives and
Capital Transactions Section
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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