Sold your House? Make Sure You Report It!

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If you have sold your home recently, you should take note of the new reporting rules announced by the CRA regarding the principal residence exemption (“PRE”).

The PRE applies on a pro-rata basis based on the number of years you are claiming the house as your principal residence. Form T2091 is technically required to report and claim the PRE on the sale. If you were claiming the exemption for the full period of ownership, then the gain on the sale is fully exempt from tax. The CRA’s policy until now has been that no reporting was required in such a case.

However, for 2016 and future years, this administrative policy has changed. Form T2091 is still not required if the full exemption is claimed, However, the sale must be reported on Schedule 3 of your tax return for the year. You will need to report a description of the property,  the year of acquisition and  the proceeds of disposition. Failure to report the sale will result in the denial of the PRE. However, you may go back and amend your return to report the sale and claim the exemption, subject to possible penalties of $100 per month to a maximum of $8,000.

For Quebec tax reporting, there has never been any administrative policy regarding a fully exempt sale of a principal residence and form TP-274 continues to be required.

Changes for Trusts

If your principal residence is owned by a trust, new rules will apply to you. I outlined the current rules in a previous post.

Under the new rules, only certain specialized trusts are now eligible to claim the PRE. They are alter-ego trusts, certain spousal or common law partner trusts, certain protective trusts or certain qualified disability trusts.

Starting in 2017, any trust that owns a home and does not fit within any of the categories above, will no longer be eligible for the PRE on the sale of the home. Therefore, if the house is sold before the end of 2016, the PRE can still be claimed.

For 2017 and later years, a home that was owned by a trust that no longer qualifies for the PRE will be allowed to calculate the exemption based on transitional rules that would require a valuation of the property as at the end of 2016. The PRE will be available for the “notional” gain up to the end of 2016, while the future growth in value will be subject to capital gains tax.

Anyone who currently lives in a home owned by a personal trust should consult their tax advisor.

Changes for Non-Residents

New rules will also apply to anyone who was a non-resident at the time they purchased a residential property in Canada. Under the current rules, the pro-rata formula that is used to calculate the PRE allows for an extra year (the plus 1 rule) in calculating the exemption. This generally allows for the fact that in a year where someone sells their home, they may own two properties, both of which should qualify for the exemption.

For a non-resident, the plus 1 rule allowed them to claim a portion of their gain as exempt, even though they never qualified since they were non-residents of Canada. Accordingly, for all sales on or after October 3, 2016, the Plus 1 rule will no longer be available to any taxpayer who was a non-resident of Canada in during the year in which he or she acquired the property. There are no transitional rules to this provision.

Death of Testamentary Trust Rules

Turkey-Estate-Plan

The favourable tax rules enjoyed by estates and testamentary trusts until now are almost dead.  Major changes that were introduced in the 2014 federal budget are about to come into effect on January 1, 2016. Don’t be caught off guard.

Estate vs. Testamentary Trust

Until now, most of us have viewed a testamentary trust in basically the same way we would an estate. They both essentially were included in the definition of a “Testamentary Trust”, meaning a trust arising as a consequence of the death of an individual. As such, they were treated in similar fashion under the law, both benefiting from graduated tax rates and both able to have an off-calendar fiscal period for tax purposes.

But now, we must make a distinction between an estate and a testamentary trust.

A testamentary trust is generally a trust that is created by the will of the deceased person. Assets from the deceased’s estate are transferred to the trust for the benefit of named beneficiaries. These assets are then administered by designated trustees. Such a trust could go on for an indefinite period of time, depending on the terms of the trust.

On the other hand an estate is essentially the bundle of assets owned by an individual at the time of death, which is to be distributed by the liquidator to the beneficiaries pursuant to the will within a relatively short period of time. The CRA likes to refer to the “executor’s year”, implying that it should take a year or so to clear the estate and distribute the assets. In many cases it may take longer.

Elimination of Benefits to Testamentary Trusts

Now that we have our terms of reference, the first thing to note is that beginning in 2016, most testamentary trusts will no longer benefit from graduated tax rates, and they will have to switch to calendar taxation years. The only exception will be for “Qualified Disability Trusts”, which essentially is a testamentary trust with a beneficiary that qualifies for the disability tax credit.

There are no grandfathering rules. All existing testamentary trusts will have to cut off their taxation years on December 31, 2015. This could result in many trusts having two tax years in 2015. You should note that the due date for the first of these calendar taxation years will be March 30, 2016.

Furthermore, beginning in 2016, these trusts will:

  • be subject to the highest marginal tax rates
  • will have to make quarterly tax instalments
  • will lose the $40,000 alternative minimum tax exemption
  • will lose the ability to object to an assessment within one year (i.e. the 90 day deadline will apply)
  • will lose the ability to transfer investment tax credits to its beneficiaries
  • will lose the right to apply for a refund after the normal reassessment period
  • may become subject to part XII.2 tax on certain types of income where non-resident beneficiaries exist

Graduated Rate Estates

On the other hand, estates may continue to benefit from graduated rates and off-calendar fiscal years, under certain conditions. Estates that meet the requirements will be known as “Graduated Rate Estates” (“GRE”).

A GRE will qualify only under the following conditions:

  • no more than 36 months have passed since the death of the individual
  • the estate otherwise meets the definition of a “Testamentary Trust” under the law
  • the estate designates itself as a GRE in its tax return for the first taxation year ending after 2015
  • the deceased individual’s social insurance number is provided in the tax return
  • no other estate is designated as the GRE with respect to that individual.

Once 36 months has expired, the estate will no longer be a GRE and will become subject to the less favourable rules described above.

Charitable Donations by a GRE

Currently, a charitable gift made by an estate that was designated by the will of an individual is deemed to have been made by the deceased, and is not deductible within the estate.

Beginning in 2016, a GRE will benefit from new and more flexible rules regarding the claiming of charitable donations. If the estate is a GRE, then such donations may be claimed by:

  • the deceased in the year of death or the preceding year
  • the estate in the year in which the donation is made, or
  • the estate in an earlier taxation year or subsequent 5 years.

Other Changes

Other more complex changes regarding testamentary trusts are coming into effect as well, but a detailed description of these is beyond the scope of this short summary. Briefly, the election to pay tax within a trust, notwithstanding that income is paid to beneficiaries, will be virtually eliminated, unless certain conditions apply.

Finally, for testamentary life interest trusts, such as spousal trusts, upon the death of the beneficiary, a year-end will occur, and any gains or income triggered upon death will be deemed to have been paid to the beneficiary’s estate, making it liable for the taxes on death. This may create a mismatch between the liability for taxes and the ownership of the assets in cases where trust capital is to be paid out to persons who are not beneficiaries of the deceased beneficiary’s estate. A common circumstance where this issue could become a problem is in a case such as a second marriage where children from the first marriage are to receive the capital of a spousal trust upon the death of the beneficiary spouse.

 

The Corporate Beneficiary

The brain is a wonderful organ. It starts working the moment you get up  in the morning and does not stop until you get into the office.     –Robert Frost

Despite the limitations placed upon it by recent legislation and unfavourable court rulings, the family trust remains alive and thriving more than ever. More and more taxpayers are beginning to appreciate the tax saving possibilities of income-splitting.

The discretionary family trust generally provides for maximum flexibility with respect to income splitting. The trustee has the power to allocate income or capital of the trust to the beneficiary of his choice.

In a simple structure, a trust is created, with children and/or a spouse as beneficiaries. The trust owns shares of an operating company (“Opco”) which pays annual dividends to the trust. The dividends are then distributed to the beneficiaries and taxed at their graduating marginal rates.

One interesting spin on the family trust is to add a corporation to the list of trust beneficiaries. This option, although it involves more legal and accounting costs, provides even more flexibility and advantages to the common family trust.

In an income splitting situation, it may not be desirable to pay more dividends to the beneficiaries than they require. If Opco has high retained earnings, its directors may find such a limitation restraining.

Adding a holding company (“Holdco”) to the list of beneficiaries wipes out this limitation. Opco could pay a large dividend to the trust. The trustee would allocate a portion of the dividend to the individual beneficiaries, and the excess would be assigned to Holdco.

A dividend paid by one corporation to a connected company is non-taxable. However, since Holdco does not own any shares directly in Opco, care would have to be exercised to ensure that the two companies were technically connected for tax purposes. Generally, this could be accomplished if Opco and Holdco were controlled by persons who do not deal at arm’s length with each other.

Where Opco generates high levels of cash, the ability to pay dividends in this manner provides certain advantages. First, it allows protection from creditors in that cash may easily be moved out through dividends and away from potential claims.

Where individual beneficiaries have not claimed their capital gains exemption, this structure provides an easy means of having the company qualify as a small business corporation by paying excess “non business” cash out as a dividend.

Sometimes, the implementation of a family trust involves an estate freeze. In such a case, corporate attribution rules may apply to assign deemed dividends to the value of preferred shares issued to a parent as part of the freeze. One exception to this rule is to ensure Opco remains a small business corporation throughout the year. The ability to pay unlimited dividends to the trust on an ongoing basis would allow Opco to retain its small business corporation status so the exception. applies.

Finally, if the trust is wound up, it may be possible to distribute the Opco shares to Holdco free of tax, thereby eliminating the need to give up eventual ownership of the shares to children.

Of course, before implementing any such complex structure, care should be taken to ensure that all legal requirements are met, and that the tax advantages are worth the added costs

The Corporate Beneficiary

The family trust is alive these days and thriving more than ever. More and more taxpayers are beginning to appreciate the tax saving possibilities of income-splitting. The trustee has the absolute power to allocate income or capital of the trust to any beneficiary of his choice with no restrictions.

In a simple structure, a trust is created, with children as beneficiaries. The trust owns shares of an operating company (“Opco”) which pays annual dividends to the trust. The dividends are then distributed to the beneficiaries and taxed at their graduating marginal rates.

One spin on the family trust is to add a corporation to the list of trust beneficiaries. This option provides even more flexibility and advantages to the common family trust.

In an income splitting situation, it may not be desirable to pay dividends to the trust over a certain amount – that is the amount that would yield the lowest rates of tax when distributed to beneficiaries. For example, a Quebec taxpayer with no other income may earn up to $12,500 in dividends before paying any tax. The trustee may not wish to distribute more than this amount to the beneficiaries annually. If Opco has high income, its directors may find such a limitation restraining.

Adding a holding company (“Holdco”) to the list of beneficiaries wipes out this limitation. Opco could pay a large dividend to the trust. The trustee would allocate a portion of the dividend to the individual beneficiaries, and the excess would be assigned to Holdco.

A dividend paid by one corporation to a connected company is non-taxable. However, since Holdco does not own any shares directly in Opco, care would have to be exercised to ensure that the two companies were technically connected for tax purposes. Generally, this could be accomplished if the trust controlled Opco, or Opco and Holdco were controlled by persons who do not deal at arm’s length with each other.

Where Opco generates high levels of cash, the ability to pay dividends in this manner provides certain advantages. First, it allows protection from creditors in that cash may easily be moved out through dividends and away from potential claims.

Where individual beneficiaries have not claimed their capital gains exemption, this structure provides an easy means of having the company qualify as a small business corporation by paying excess “non business” cash out as a dividend.

Sometimes, the implementation of a family trust involves an estate freeze. In such a case, corporate attribution rules may apply to assign deemed dividends to the value of preferred shares issued to a parent as part of the freeze. One exception to this rule is to ensure Opco remains a small business corporation throughout the year. The ability to pay unlimited dividends to the trust on an ongoing basis would allow Opco to retain its small business corporation status so the exception applies.

Finally, if the trust is wound up, it may be possible to distribute the Opco shares to Holdco free of tax, thereby eliminating the need to give up eventual ownership of the shares to children.

Before implementing any such complex structure, care should be taken to ensure that all legal requirements are met, and that the tax advantages are worth the added costs.

What’s Your Tax Issue? – Gift of RRIF on Death

The Tax Issue:

My Mom passed away very recently. She had indicated designated beneficiaries of her RRIF with varying percentages – none to the estate. One of these is her church, a charitable organization.  My understanding is that I can not claim the RRIF amount to the charity as a charitable donation (because it has not passed through the estate), although I’m not sure exactly why.

No one seems to be able to answer this and, in fact, the whole income tax issue on RRIF’s at death was quite befuddling – with each person I asked (ie. financial planner, lawyer) pointing me in another direction 🙂

If you have any thoughts on this, could you please pass them along? Thanks.

The Answer:

Well, yes, the subject of RRIF’s on death is indeed befuddling, as I pointed out in a previous post, and I always get excited when a question begins with the phrase “no one seems to be able to answer this…”

There are two parts to the answer. The first is, who gets taxed on the proceeds from the RRIF? Upon death, the general rule is that the full amount coming out of the RRIF is taxable unless it qualifies for a rollover. The church is not a qualified beneficiary, so the full amount of the RRIF will be a taxable amount to be added to your Mom’s final tax return.

Next question: can the amount that goes to the church be claimed as a tax credit for gifts? Under rules that have existed since the olden days, a gift made to a registered charity by virtue of an individual’s will is deemed to be a gift made by the individual immediately prior to her death, and may be claimed on her final return. Your advisors are confused because the gift is a direct designation in the RRIF, and not made by virtue of the will.

We have come a long way since the olden days. In 2004, the law was amended to give similar treatment to gifts made as direct designations through a RRIF. The only stipulation is that the transfer of funds must occur with 36 months of death.  Accordingly, although the RRIF is taxable in your Mom’s final return, her estate will also benefit from a corresponding tax credit for the gift made to the church.

The RRIF administrator should issue a T4A in the name of your mother for the full amount of the RRIF. The church should issue a charitable donation receipt to the estate for the amount it receives.

The End Of The Irritants

If you are the executor of an estate with non-resident beneficiaries, life just got a bit simpler. The federal budget of 2010 contained amendments to the definition of “taxable Canadian property” that will eliminate the irritating requirement to file requests for clearance certificates.

Until now, any capital interest in a trust or estate resident in Canada fell under the definition of “taxable Canadian property”. As such, the CRA has always taken the position that any distribution of capital by an executor or trustee constitutes a “disposition” by the beneficiary of a capital interest in that trust or estate. Where the beneficiary is a non-resident of Canada,  section 116 of the Income Tax Act requires that a clearance certificate be obtained within 10 days of the disposition. I discussed section 116 certificates in a previous post.

Most of Canada’s tax treaties would generally serve to exempt the beneficiary from any Canadian tax, so the entire process was often just a formality and a pesky irritant to trustees, and especially to unsuspecting estate executors who simply wanted to make even a partial payment of capital to a beneficiary.

New rules that took effect in 2009 served to reduce the compliance burden by eliminating the need for a clearance certificate where the trustee or executor was certain that the beneficiary was protected by a Canadian tax treaty. However, this required work to make the determination of residency of the beneficiary, analyze the relevant treaty and determine whether the beneficiary was related to the estate, and if so, report the distribution to the CRA.

With the budget of 2010, the definition of “taxable Canadian property” has been amended, and trusts and estates no longer fall within the definition at all, unless they owned significant amounts of Canadian real estate at any time within the prior 60 months.

This change will eliminate a major compliance burden for estate executors. The new rules will also eliminate Canadian private corporations and partnerships from the definition of taxable Canadian property in the same fashion as above.

Some work will still be required to ensure that the assets of the estate or trust have not contained significant real estate, but other than that, these rules are a welcome relief to Canadian executors.