17 June 2025 STEP Roundtable Q. 10, 2025-1054541C6 - Principal Residence Exemption and Subsection 73(1) Transfer to a Life Interest Trust

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: Whether a taxpayer who transfers two properties to a life interest trust under subsection 73(1) of the Act, (each of which could meet the requirements to qualify and be designated as the taxpayer’s principal residence), must make their principal residence designation for the years preceding the transfer, at the time of: (1) the subsection 73(1) transfer; (2) the sale of the properties by the life interest trust or (3) upon the death of the life interest trust beneficiary.

Position: The principal residence designation for the years prior to the transfer of the properties to the life interest trust is required to be filed with the taxpayer's return of income for the taxation year that includes the subsection 73(1) transfer of the properties since a disposition of the properties is generally considered to have occurred at the time of the transfer.

Reasons: The legislation. In particular, subparagraph 40(4)(b)(ii) and the definition of "disposition" in subsection 248(1) of the Act and section 2301 of the Regulations.

2025 STEP CRA Roundtable – June 17, 2025

QUESTION 10. Principal Residence Exemption and Subsection 73(1) Transfer to a Life Interest Trust

An individual, over age 65, transfers a “city” and a “recreational” property that could both otherwise qualify as their principal residence to a life interest trust (“LIT”). (footnote 1) The properties have been owned for many years and there is the desire to maintain flexibility as to which property will be designated as the principal residence upon an ultimate sale by the LIT. By virtue of subparagraph 40(4)(b)(ii) and assuming subsection 73(1.01) applies, the property will be the principal residence of the LIT for any year that it was the principal residence of the transferor taxpayer. This differs from the language in subparagraph 40(4)(b)(i) which, in the case of a transfer to a testamentary spouse trust, refers to if the property had been designated as the principal residence of the transferor.

Does this mean that the individual must choose which of the city or recreational property they will designate as their principal residence for the years prior to the transfer at the time of transfer, as opposed to when the life interest beneficiary dies, or at the time of the ultimate sale by the LIT?

CRA Response

The CRA’s general views on claiming the principal residence exemption (“PRE”) are set out in Income Tax Folio S1-F3-C2 “Principal Residence” (“Folio”). Generally, if a property qualifies as a taxpayer’s principal residence as defined in section 54 of the Income Tax Act (“Act”), an exemption can be claimed under paragraph 40(2)(b) of the Act to reduce or eliminate any capital gain otherwise occurring for income tax purposes on the disposition (or deemed disposition) of the property. The definition of “principal residence” provides the conditions which must be met for a property that is a housing unit to qualify as a taxpayer’s principal residence, including, in paragraph (c), that the taxpayer designates the property as their “principal residence” for the year. Additionally, no other property can be designated by the taxpayer for the year and, where the designation is for a year after 1981, no other property can be designated as the principal residence of any member of the taxpayer’s family unit for the year, as described in paragraph 2.13 of the Folio.

In general, subsection 40(4) of the Act is applicable on the disposition of a property by an individual, that was previously acquired from a taxpayer (“Transferor”) pursuant to the rollover provisions of subsection 70(6) or 73(1) of the Act. In particular, this subsection deems certain conditions to have been met for the purpose of determining the individual’s (“Transferee”) gain under paragraph 40(2)(b) on a subsequent disposition of the property. More specifically, pursuant to paragraph 40(4)(a), the Transferee is deemed to have owned the property throughout the period during which the Transferor owned it. Paragraph 40(4)(b) provides that:

(i) in the case of property transferred under subsection 70(6), the property shall be deemed to have been the Transferee’s principal residence for any taxation year for which it would, if the Transferor had designated it in prescribed manner to have been the Transferor’s principal residence for that year, have been the Transferor’s principal residence; and

(ii) in the case of property transferred under subsection 73(1), the property shall be deemed to have been the Transferee’s principal residence for any taxation year for which it was the Transferor’s principal residence.

In general terms, the effect of subsection 40(4) is to make it possible for the Transferee to claim the PRE under paragraph 40(2)(b) for taxation years when the property would have been, or was, as the case may be, the Transferor's principal residence.

The difference between the application of subsection 40(4) to property acquired pursuant to subsection 73(1) (an inter vivos transfer of capital property) and to property acquired pursuant to subsection 70(6) (a transfer of capital property on death) is that property transferred in the latter situation (that is, on death) is deemed to be the principal residence of the Transferee for each year in which it was eligible to be the deceased Transferor’s principal residence rather than just for each year in which it actually was the Transferor’s principal residence. The stricter language in subparagraph 40(4)(b)(ii) of the Act that pertains to a subsection 73(1) transfer imposes a requirement for the designation condition in the principal residence definition to be satisfied by the Transferor.

The principal residence designation condition for individuals, mentioned earlier, requires that the designation must be made by the taxpayer in a prescribed form and manner. The prescribed form for an individual (other than a trust) to make their principal residence designation is the T2091IND Designation of a Property as a Principal Residence by an Individual (Other Than a Personal Trust) (“T2091 Form”). The prescribed manner of designation is described in section 2301 of the Income Tax Regulations (“Regulations”), which provides that any designation by a taxpayer under the principal residence definition shall be made in the return of income required by section 150 of the Act to be filed by him for any taxation year of the taxpayer in which (a) he has disposed of property that is to be designated as his principal residence; or (b) he has granted an option to acquire such property.

In general terms, according to paragraph (c) of the definition of the term “disposition” in subsection 248(1) of the Act, a disposition of any property is defined to include “any transfer of the property to a trust, except as provided by paragraph (f) or (k)” of that definition. In our view, generally, neither of the exceptions in paragraphs (f) or (k) would apply to the situation you have described. Furthermore, it is our view that the exclusion in paragraph (e) of the definition of “disposition” would not apply to the situation. Accordingly, a transfer of a property by a taxpayer pursuant to subsection 73(1) will generally constitute a “disposition” within the meaning of the term in subsection 248(1), and will therefore require a taxpayer to file a principal residence designation form (that is, a T2091 Form) in their tax return for the year in which the disposition occurs in order to satisfy the principal residence requirements.

In summary, even though the transfer of the properties takes place on a tax deferred basis pursuant to subsection 73(1), a disposition is generally considered to occur on a transfer of a property to a trust, including a life interest trust. Therefore, in accordance with the legislation (section 2301 of the Regulations), the Transferor must file a T2091 Form and make the decision of which of their two properties to designate as their principal residence for the years preceding the transfer with their return of income for the year in which the disposition of the property occurs. It follows that, in accordance with subparagraph 40(4)(b)(ii), when the life interest trust disposes of the property, it will be deemed to have been the life interest trust’s principal residence for the taxation years for which it was the Transferor’s principal residence.

Christina Foggia
2025-105454

FOOTNOTES

Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:

1. A life interest trust generally includes an alter ego trust, a joint spousal or common-law partner trust, and a spousal trust, which are trusts that are generally described in paragraph 73(1.01)(c) of the Act. Furthermore, subject to the requirements of subsection 73(1.02), a qualifying transfer for purposes of subsection 73(1) of the Act includes property transferred by an individual in circumstances to which subsection (1.01) applies where it is transferred, among others, to one of the trusts described in paragraph 73(1.01)(c).