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. Whether the farm house can qualify for the principal residence exemption in paragraph 40(2)(b) of the Income Tax Act (the "Act"). 2. Whether the farm land can qualify as a qualified farm property for the purposes of the capital gains exemption in section 110.6 of the Act.
Position: 1. Question of facts. 2. Question of facts.
Reasons: General comments provided.
XXXXXXXXXX 2010-036518
André Gallant
(613) 957-8961
July 30, 2010
Dear XXXXXXXXXX :
Re: Principal residence and qualified farm property
This is in response to your letter of April 16, 2010, regarding the principal residence exemption and the capital gains exemption for a qualified farm property ("QFP") under the Income Tax Act (Canada) (the "Act"). We apologize for the delay in responding to your request.
Our understanding of the facts is as follows:
1. Your XXXXXXXXXX died on XXXXXXXXXX . You are one of XXXXXXXXXX beneficiaries and one of XXXXXXXXXX executors of XXXXXXXXXX estate. Your XXXXXXXXXX sons, your XXXXXXXXXX and your XXXXXXXXXX are the other beneficiaries of the estate.
2. The estate owned a farm of approximately XXXXXXXXXX acres in the Province of XXXXXXXXXX . The farm was eventually sold XXXXXXXXXX .
3. From the date of your XXXXXXXXXX's death until the sale of the farm, you lived in the farm house. The only other beneficiary who lived in the farm house for an extended period of time was one of your sons (the "Son"). You and your Son did not designate any property as a principal residence during the time you each lived on the farm. In the year your Son moved out of the farm house, he purchased another house and has been designating that property as his principal residence ever since. Since moving out of the farm house, your Son has only occasionally visited you in the farm house.
4. Your XXXXXXXXXX visited the farm on approximately XXXXXXXXXX occasions since your XXXXXXXXXX died. None of these visits lasted for more than XXXXXXXXXX days. Your XXXXXXXXXX has designated a property as a principal residence during the time that the estate owned the farm.
5. Your XXXXXXXXXX never visited the farm house since XXXXXXXXXX died. Your other XXXXXXXXXX sons never lived in the farm house while the estate owned it, although they did visit you occasionally.
6. The farm land surrounding the farm house was leased by the estate to a neighbouring farmer who actively farmed it. While your parents owned the farm, they farmed the land for almost XXXXXXXXXX years.
Your question concerns whether the farm house can qualify for the principal residence exemption in subsection 40(2)(b) of Act and the farm land can qualify as a QFP for the purposes of the capital gains exemption in section 110.6 of the Act. XXXXXXXXXX .
Our Comments
Written confirmation of the tax implications inherent in particular transactions 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, Advance Income Tax Rulings, dated May 17, 2002. Where the particular transactions are completed, the inquiry should be addressed to the relevant Tax Services Office (the "TSO"). We are, however, prepared to offer the following general comments, which may be of assistance.
Principal residence
Where a personal trust sells a residence, the tax consequences will depend, inter alia, on whether or not that residence is a "principal residence" under section 54 of the Act. A personal trust is defined in subsection 248(1) of the Act as including a testamentary trust. A testamentary trust is further defined as including an estate that arose on and as a consequence of the death of an individual.
It is possible for a personal trust to claim the principal residence exemption to reduce or eliminate a gain that the trust would otherwise have on the disposition of a property. Generally, a housing unit may be designated as a principal residence of a personal trust that is resident in Canada for each taxation year in which the property is ordinarily inhabited in a calendar year ending in the taxation year by a specified beneficiary of the trust or by the spouse or common-law partner, former spouse or common-law partner or a child of the specified beneficiary. If the property qualifies as the personal trust's principal residence for one or more taxation years in which the personal trust owned the property, the principal residence exemption may be used to reduce or eliminate any capital gain which would otherwise be required to be included in the personal trust's income. We refer you to IT-120R6, Principal Residence, as well as forms T1079, Designation of a Property as a Principal Residence by a Personal Trust, and T1079-WS, Principal Residence Worksheet, for a detailed explanation of how to calculate the amount of the principal residence exemption. These publications are available on our website at www.cra-arc.gc.ca.
In order to qualify as a "specified beneficiary", a person must meet two requirements. First, the person must be an individual who is "beneficially interested" in the trust. The term "beneficially interested" is partially defined in the Act. A person beneficially interested in a trust includes any person that has a right as a beneficiary under a trust to receive income or capital of the trust. Since the amendment to that definition in 1997 to make it an "inclusive" type of definition, the term may now include a person who has the right to reside in a housing unit owned by the trust rent-free. Whether or not an individual is "beneficially interested" in a trust is a question of fact that can only be determined upon a review of all the facts by the relevant TSO.
The second requirement to be a specified beneficiary is that the person beneficially interested (except where the trust is entitled to designate a housing unit for the year because of an election under subsection 45(2) or (3) of the Act) also has to ordinarily inhabit the housing unit or have a spouse or common-law partner, former spouse or common-law partner or child who ordinarily inhabits the housing unit. Whether or not a person ordinarily inhabit a housing unit is a question of fact that can only be determined upon a review of all the facts by the relevant TSO. However, while a person might be considered to ordinarily inhabit a seasonal residence occupied only during his or her vacation, a person who only visits a property occasionally (even if the property is owned or co-owned by that person) is normally not considered to have ordinarily inhabited that property.
You will find in paragraph 35 of Interpretation Bulletin IT-120R6 a list of conditions that must be met to claim the principal residence exemption for a taxation year. Where a personal trust designates a property as its principal residence for a particular taxation year, the property is deemed to be property designated, for the calendar year ending in the year, as the principal residence of each specified beneficiary of the trust. In such a case, the specified beneficiary or a person who throughout the calendar ending in the year was a member of such a beneficiary's family unit (discussed in paragraph 35 of IT-120R6) cannot designate another property as his/her principal residence for that year.
The situation you described involved farm land where the housing unit is situated that is in excess of 1/2 hectare (1/2 hectare is approximately equal to 1.24 acres). Under the definition of "principal residence" in section 54 of the Act, the principal residence is deemed to include the land subjacent to the housing unit and such portion of any contiguous land as can reasonably be regarded as contributing to the use and enjoyment of the housing unit as a residence. However, if the total area of the subjacent and portion of contiguous land where the housing unit is situated exceeds 1/2 hectare, the excess land is considered not to be part of the principal residence unless the taxpayer establishes that such excess land is necessary for the use and enjoyment of the housing unit as a residence. 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.
A minimum lot size and a severance restriction imposed by local municipal by-laws ("zoning by-laws") may be factors indicating that land in excess of 1/2 hectare may be required for the use and enjoyment of the housing unit as a residence. However, as indicated in paragraph 16 of IT-120R6, the zoning by-laws are not relevant for any portion of the land in excess of 1/2 hectare that is not used for residential purposes but rather is used for income-producing purposes; such portion would therefore not usually be considered to be necessary for the use and enjoyment of the housing unit as a residence. Yet again, if the income earned on the land in excess of 1/2 hectare is only minimal in the circumstances, the zoning by-laws would normally then remain relevant.
Qualified farm property
Subject to the special rule in respect of spouse or common-law partner trusts ("spousal trusts") under subsection 110.6(12) of the Act, only individuals (other than trusts) that are resident in Canada throughout a taxation year may claim the capital gains exemption under subsection 110.6(2) of the Act in respect of QFP. The estate in your situation would not qualify as a spousal trust for the purposes of subsection 110.6(12).
However, if the estate makes a designation of a portion of its net taxable capital gains for a taxation year in favour of a particular beneficiary (to the extent the portion is otherwise part of the amount that, by virtue of subsection 104(13) or (14) or section 105, is included in the beneficiary's income) under subsection 104(21) of the Act, the portion is generally deemed to be a taxable capital gain of the beneficiary from the disposition of capital property. If a personal trust makes a designation under subsection 104(21), it is required to make a further designation under subsection 104(21.2) in respect of its eligible taxable capital gains, which arise from the disposition by the personal trust of capital properties, such as QFP, that qualify for the capital gains deduction under section 110.6. Essentially, the amount designated by a personal trust in respect of a beneficiary under the rules of subsection 104(21.2) is treated in the hands of the beneficiary as a taxable capital gain from the disposition of capital property that may qualify for the capital gains deduction under section 110.6.
Interpretation Bulletin IT-381R3, Trusts - Capital Gains and Losses and the Flow-Through of Taxable Capital Gains to Beneficiaries (especially paragraphs 5 to 7) discusses the flow-through of taxable capital gains to beneficiaries. This publication is also available on the CRA website at www.cra-arc.gc.ca.
The definition of QFP in subsection 110.6(1) of the Act provides, inter alia, that QFP includes "real or immovable property that was used principally in the course of carrying on the business of farming in Canada" by certain qualifying users, who may include an individual (other than a trust that is not a personal trust). Subsection 110.6(1.3) provides that a property will not be considered to have been used in the course of carrying on the business of farming in Canada unless the ownership test in paragraph (a) thereof is satisfied and, in addition, one of the farming-use tests in paragraph (b) or (c) thereof is met. Which farming-use test is applicable depends on when the taxpayer last acquired the property. In your situation, since the property was acquired by the estate after June 17, 1987, the applicable farming-use test would be the one referred to in paragraph (b).
Whether the farming-use test in paragraph 110.6(1.3)(b) or (c) is met depends in part on which persons are included in the ownership test in paragraph (a), as it will be illustrated below.
The ownership test in paragraph 110.6(1.3)(a) will be met in respect of property of an individual if, according to the statutory wording,
"throughout the period of at least 24 months immediately preceding that time, the property or property for which the property was substituted (in this paragraph referred to as "the property") was owned, by any one or more of
(i) the individual, or a spouse, common-law partner, child or parent of the individual,
(ii) a partnership, an interest in which is an interest in a family farm partnership of the individual or of the individual's spouse or common-law partner,
(iii) if the individual is a personal trust, the individual from whom the trust acquired the property or a spouse, common-law partner, child or parent of that individual, or
(iv) a personal trust from which the individual or a child or parent of the individual acquired the property..."
A taxpayer's "parent" and "child" would include a grandparent and grandchild by virtue of the definition of "child" in subsection 110.6(1), which refers to the meaning assigned by subsection 70(10) of the Act. Furthermore, based on the wording used for the ownership test in paragraph 110.6(1.3)(a) ("throughout the period of at least 24 months immediately preceding that time"), the farming use described in paragraph 110.6(1.3)(b) must occur during an uninterrupted period of ownership by eligible owners.
The farming-use test in paragraph 110.6(1.3)(b)will be met if, according to the statutory wording,
"(i) in at least two years while the property was owned by one or more persons referred to in paragraph (a),
(A) the gross revenue of a person (in this clause referred to as the "operator") referred to in paragraph (a) from the farming business referred to in clause (B) for the period during which the property was owned by a person described in paragraph (a) exceeded the income of the operator from all other sources for that period, and
(B) the property was used principally in a farming business carried on in Canada in which an individual referred to in paragraph (a), or where the individual is a personal trust, a beneficiary of the trust, was actively engaged on a regular and continuous basis, or
(ii) throughout a period of at least 24 months while the property was owned by one or more persons or partnerships referred to in paragraph (a), the property was used by a corporation referred to in subparagraph (a)(iv) of the definition "qualified farm property" in subsection (1) or by a partnership referred to in subparagraph (a)(v) of that definition in a farming business in which an individual referred to in any of subparagraphs (a)(i) to (iii) of that definition was actively engaged on a regular and continuous basis;"
Whether or not an individual is actively engaged on a regular and continuous basis in the operation of a farm business in a particular case is a question of fact that can only be resolved by reviewing the documents and surrounding circumstances of the case. Such a determination, as it may relate to any specific case, is generally made by the relevant TSO. Paragraph 27 of Interpretation Bulletin IT-268R4, Inter Vivos Transfer of Farm Property to a Child, reflects the CRA's interpretation of the phrase "actively engaged on a regular and continuous basis". This publication is also available on our website at www.cra-arc.gc.ca.
For additional information concerning the tax implications in the scenario you described, you may wish to seek professional tax advice.
We trust that these comments will be of assistance.
Yours truly,
S. Parnanzone
Manager
For Director
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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