7 March 2016 Internal T.I. 2016-0629951I7 - Principal Residence Exemption

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: Is the taxpayer's land in excess of one-half hectares considered necessary to the use and enjoyment of the housing unit, notwithstanding the fact that the majority of the land was used to earn farm income?

Position: Question of fact, but likely no. Paragraph 40(2)(c) will apply to the disposition.

Reasons: Where any portion of the land in excess of one-half hectare is used for income-producing purposes, such portion would not usually be considered to be necessary for the use and enjoyment of the housing unit as a residence.

                                                March 7, 2016

Technical Section                               HEADQUARTERS
Business Audit Division                         Income Tax Rulings
Small and Medium Enterprises Directorate          Directorate
Compliance Programs Branch                      T. Posadovsky

Attention: James Smith                          2016-062995

Principal Residence Exemption, Farmland with Minimum Lot Size Restriction

We are writing in response to your memo of January 28, 2016, wherein you requested our views concerning the disposition of a taxpayer’s principal residence in circumstances where the housing unit was situated on land that was also being used in a farming business (the “Property”). You wish to know if the principal residence exemption (“PRE”) provisions under the Income Tax Act (the “Act”) will apply to eliminate or reduce the taxpayer’s gain in the fact situation provided.

Facts

Briefly, our understanding of the facts is as follows:

• Mrs. L (the “Taxpayer”) sold the XXXXXXXXXX hectare Property in XXXXXXXXXX. The Taxpayer’s disposition of the Property is under review by Audit at the XXXXXXXXXX Tax Services Office.
• The Property was purchased in XXXXXXXXXX by the Taxpayer’s spouse with the intention to use the housing unit situated thereon as a principal residence.
• The Taxpayer’s spouse began to use the land in a XXXXXXXXXX farming business that same year.
• Approximately 95% of the Property was used to earn income from farming.
• Title to the Property was transferred to the Taxpayer in XXXXXXXXXX when the Taxpayer’s spouse became ill. The Taxpayer’s spouse passed away in XXXXXXXXXX.
• From the time the Taxpayer’s spouse passed away until the Property was sold in XXXXXXXXXX, the Taxpayer continued to use the Property to earn income from a farming business. This was a significant source of income for the Taxpayer.
• The sale of the Property resulted in a gain of approximately $XXXXXXXXXX dollars. The Taxpayer did not report the disposition and gain on Schedule 3 of her T1 Income Tax Return.

The Taxpayer’s position

The Taxpayer’s representative provided a written submission explaining that at the time it was acquired, the Property was intended to be the Taxpayer’s principal residence and it was properly designated as such on form T2091, Designation of a Property as a Principal Residence by an Individual, for all the years of ownership. Although the definition of “principal residence” generally does not include land in excess of one-half hectare, the representative argues the excess land was necessary to the Taxpayer’s use and enjoyment of the housing unit as a residence. This is because the Property could not be legally subdivided due to minimum lot size restrictions and its inclusion in the Agricultural Land Reserve.

In support of this view, the representative explains that there have been several cases in which the courts have allowed designation of a whole property as a principal residence where the property could not have been divided into two or more parcels due to municipal by-law restrictions. The representative noted the decision of the Federal Court of Appeal (FCA) in Grace Carlile v the Queen, 95 DTC 5483 (“Carlile”).

Our Comments

If a property qualifies as an individual’s principal residence, he or she can use the PRE under paragraph 40(2)(b) of the Act to eliminate or reduce a capital gain that otherwise occurs on the disposition (or deemed disposition) of the property. Among other things, the definition of “principal residence” in section 54 of the Act sets out the various criteria for a housing unit and the land it is situated on to qualify as a principal residence. Paragraph (e) of the definition generally deems to include the land upon which the housing unit stands and any portion of the surrounding or adjoining land that can reasonably be regarded as contributing to the use and enjoyment of the housing unit as a residence. However, any land in excess of one-half hectare, including the area on which the housing unit stands, is deemed to not contribute to the use and enjoyment of the housing unit as a residence unless the taxpayer establishes that it was “necessary to such use and enjoyment”. The onus is on the taxpayer to establish how much, if any, of the excess land is necessary for the use and enjoyment of the housing unit as a residence.

Income Tax Folio: S1-F3-C2, Principal Residence, discusses the various rules under which a property can be designated as an individual’s principal residence for a particular taxation year. As stated in paragraph 2.35 of S1-F3-C2, if a minimum lot size or a severance or subdivision restriction existed in any given year during which the taxpayer owned the property, the land area in excess of one-half hectare would normally be part of the principal residence for that particular year. However, while a minimum lot size or severance restriction imposed by local municipal by-laws may be a factor in indicating that land in excess of one-half hectare might be required for the use and enjoyment of the housing unit as a residence, it is not the only consideration. Other factors, such as whether a portion of a taxpayer’s property is being used for income-producing purposes or whether there has been a partial change in use, also need to be taken into account.

The issue of minimum lot size and severance restrictions was examined in Carlile as well as in The Queen v Yates, 86 DTC 6296 (“Yates”), and Augart v The Queen, 93 DTC 5205 (“Augart”). In each of these cases, the FCA held that the land in excess of that specified in the legislation was necessary to the use and enjoyment of the housing unit as a residence. However, it would appear that the facts in this situation are materially different from those in Yates, Augart and Carlile. In each of those cases, the income earned on the excess land was minimal under the circumstances and ancillary to each taxpayer’s use of the land as a principal residence. Conversely, the majority of the Taxpayer’s land in this case was being used in a farming business that was a significant source of income for the Taxpayer. As such, and as explained in paragraph 2.32 of S1-F3-C2, where a portion of a taxpayer’s land is used to earn income from business or property, such portion will not usually be considered to contribute to the use and enjoyment of the housing unit as a residence.

In response to your inquiry, it is our view that the minimum lot size or severance restrictions are not as relevant in the Taxpayer’s case due to the Property’s intended and actual significant use in a farming business. Notwithstanding the minimum lot size restriction and the FCA decisions as noted above, because the majority of the Property disposed of was land used in the Taxpayer’s farming business, the disposition of the Property should be subject to the more specific rule in paragraph 40(2)(c) of the Act (disposition of land used in a farming business). Under this provision, the PRE under paragraph 40(2)(b) would be applicable to the portion of the gain on the Property in respect of the housing unit and the land it is situated on that meets the definition of a “principal residence” in section 54 of the Act. This result appears to have been clearly contemplated by Parliament.

Unless exempted, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency’s electronic library. After a 90-day waiting period, a severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. You may request an extension of this 90-day period. The severing process removes all content that is not subject to disclosure, including information that could reveal the identity of the taxpayer. The taxpayer may ask for a version that has been severed using the Privacy Act criteria, which does not remove taxpayer identity. You can request this by e-mailing us at: ITRACCESSG@cra-arc.gc.ca. A copy will be sent to you for delivery to the taxpayer.

We trust our comments will be of assistance.

Yours truly,

Michael Cooke, CPA, CA
Manager
Business Income and Capital Transaction Section
Business and Employment Division
Income Tax Rulings Directorate