Income Tax Interpretation Bulletin

Principal Residence

NO: IT-120R6

DATE: July 17, 2003

SUBJECT: INCOME TAX ACT
Principal Residence

REFERENCE: The definition of "principal residence" in section 54, and paragraphs 40(2)(b) and 40(2)(c) (also sections 54.1 and 110.6; subsections 13(7), 40(4), 40(6), 40(7), 40(7.1), 45(1), 45(2), 45(3), 45(4), 107(2), 107(2.01), 107(4), 110.6(19) and 220(3.2); paragraph 104(4)(a); and subparagraph 40(2)(g)(iii) of the Income Tax Act; and Part XXIII of the Income Tax Regulations)

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Change in Use Rules Regarding CCA, Deemed Capital Cost, and Recapture

¶ 33. If a taxpayer has completely or partially changed the use of property from principal residence to income-producing, subsection 13(7) provides for a deemed acquisition of the property or portion of the property so changed that is depreciable property. For purposes of claiming CCA, the deemed capital cost of such depreciable property is its FMV as of the date of the change in use unless that FMV is greater than its cost to the taxpayer. In that case, the deemed capital cost of such depreciable property is equal to its cost to the taxpayer plus an amount which represents the taxable portion of the accrued gain on the property (before any reduction to that gain by means of the principal residence exemption) to the extent that a section 110.6 capital gains deduction has not been claimed in respect of that amount (this latter rule has no particular significance for dispositions of residence properties occurring after February 22, 1994, because of the elimination of the $100,000 lifetime capital gains exemption for dispositions after that date).

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Example

Mr. A completely converted his house to a rental property in January 2001, at which time its cost to him and its FMV were $60,000 and $100,000 respectively (both amounts pertain only to the housing unit and not the land). The change in use resulted in a deemed disposition of the property at FMV (see ¶s 25 and 26 – assume that Mr. A did not make a subsection 45(2) election in respect of the property because he wanted to use the principal residence exemption for his cottage for the years after 2001). Mr. A was able to use the principal residence exemption formula in ¶ 8 to bring his gain on the January 2001 deemed disposition of the house to nil. Mr. A's deemed capital cost for the house (i.e., for CCA purposes) at the time of its change in use to a rental property was $80,000. This amount was calculated by taking the $60,000 cost and adding $20,000, the latter amount being one-half of the excess of the $100,000 FMV over the $60,000 cost. (Note that the $20,000 potentially taxable portion of the gain was included in Mr. A's deemed capital cost for CCA purposes even though he eliminated the gain by means of the principal residence exemption.)

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In the case of a complete change in use of a property from principal residence to income-producing, a subsection 45(2) election will cause subsection 13(7), as described above, not to apply. However, if the election is rescinded in a subsequent taxation year (e.g., by claiming CCA on the property – see ¶ 25), a subsection 13(7) deemed acquisition of depreciable property will occur on the first day of that subsequent year.

Because a subsection 45(2) election is not available where there is only a partial change in use of a property from principal residence to income-producing, subsection 13(7) applies in such a situation in the manner described above (except where conditions (a) to (c) in ¶ 32 have been met, including the condition not to claim CCA on the portion of the property used to earn income).

¶ 34. If a taxpayer completely or partially changes the use of a property from income-producing to principal residence, there is a deemed disposition at FMV, by virtue of subsection 13(7), of the portion of the property so changed that is depreciable property. This can result in a recapture of CCA previously claimed on the property. A subsection 45(3) election cannot be used to defer such a recapture (e.g., a recapture of CCA claimed for a taxation year ending before 1985 – see the comments regarding CCA in ¶ 28).

Personal Trusts

¶ 35. It is possible for a "personal trust" (this term is defined in subsection 248(1) of the Act) to claim the principal residence exemption to reduce or eliminate a gain that the trust would otherwise have on the disposition of a property. For this purpose, the normal principal residence exemption rules generally apply, subject to the following modifications:

Furthermore, if 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. This deeming rule can be applied, in conjunction with the other principal residence exemption rules, to various situations not explicitly described in those rules.

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Example

Personal Trust A owned a house in its taxation year ended December 31, 2001. The house was ordinarily inhabited in 2001 by Mr. X, a specified beneficiary of Personal Trust A (and also by his spouse, Mrs. X). The trust has designated the house as its principal residence for its taxation year ended December 31, 2001. The house is therefore deemed to have been designated as Mr. X's principal residence for 2001.

Personal Trust B owned a cottage (see ¶ 3) in its taxation year ended December 31, 2001. The cottage was ordinarily inhabited (see ¶ 5) in 2001 by Mrs. X, a specified beneficiary of Personal Trust B (and also by Mr. X). As discussed in ¶ 6, a taxpayer and his or her spouse or common-law partner cannot designate different properties for the same year. Therefore, since the house has already been deemed to have been designated as Mr. X's principal residence for 2001, Personal Trust B cannot designate the cottage as its principal residence for 2001 because that would have resulted in the cottage being deemed to have also been designated as Mrs. X's principal residence for 2001.

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¶ 36. Where a beneficiary has acquired a property from a personal trust in satisfaction of all or any part of the beneficiary's capital interest in the trust and

• the rollover provision in subsection 107(2) applied (see discussion in ¶ 37 for an exception to this rollover provision) and
• subsection 107(4) did not apply,

subsection 40(7) provides a deeming rule when the beneficiary disposes of the property. For purposes of claiming the principal residence exemption, the beneficiary is deemed by subsection 40(7) to have owned the property since the trust last acquired it.

The following example illustrates the effect of this deemed ownership provision in subsection 40(7) (in conjunction with subsection 107(2)).

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Example

A personal trust acquired a residential property on October 1, 1997 for $75,000. On January 10, 1999, the property was distributed to Mr. X in satisfaction of his capital interest in the trust. Subsection 107(4) did not apply with respect to this distribution, and the rollover provision in subsection 107(2) prevented the gain on the property accrued to January 10, 1999 from being taxed in the hands of the trust. Instead, the potential for taxing that gain was transferred to Mr. X because subsection 107(2) deemed him to have acquired the property at a cost equal to $75,000, i.e., the cost amount of the property to the trust. Mr. X lived in the residence from October 15, 1997 until he disposed of the property on December 1, 2001 for $125,000, incurring no costs in connection with the disposition. Mr. X's gain otherwise determined on the disposition of the property was equal to his $125,000 proceeds minus his $75,000 adjusted cost base = $50,000. Subsection 40(7) deemed him to have owned the property from October 1, 1997 rather than from January 10, 1999. Since Mr. X ordinarily inhabited the residence in all of the years from 1997 to 2001 inclusive (i.e., all of the years in which he either owned the property or was deemed to have owned it), he was able to designate the property as his principal residence for all those years. Thus, he was able to use the principal residence exemption formula in ¶ 8 to fully eliminate his $50,000 gain otherwise determined. However, if neither Mr. X nor his current or former spouse or common-law partner, or child had ordinarily inhabited the residence (see the rule discussed in ¶ 5) until it was distributed by the trust to Mr. X on January 10, 1999, he would have been able to designate the property as his principal residence only for 1999 to 2001. In other words, he would have been able to use the formula in ¶ 8 to eliminate only the following portion of his $50,000 gain otherwise determined:

A × (B ÷ C) = $50,000 × [1 + 3 (1999 to 2001)] ÷ [5 (1997 to 2001)] = $40,000

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¶ 37. In order to prevent the rollover rule in subsection 107(2) from applying with respect to a trust's distribution, to a beneficiary, of a property that qualifies for designation as the trust's principal residence before the distribution, a personal trust can use an election under subsection 107(2.01) of the Act. Under this election, the trust would instead be deemed, just before the distribution of the property to the beneficiary, to have disposed of and then to have reacquired the property at fair market value. This could be done, for example, in order for the trust to use the principal residence exemption to eliminate or reduce any gain on the property accrued to that point in time (see ¶ 35), ideal in circumstances where the recipient beneficiary is not the specified beneficiary and has owned another home during the period in which the trust owned the home being distributed. The cost of the property to the beneficiary would be that same fair market value, and the beneficiary would not be deemed by subsection 40(7) (see ¶ 36) to have owned the property during the period of time in which it was owned by the trust prior to the distribution.

Transfer of a Principal Residence

¶ 38. Subsection 40(4) can apply if a property of a taxpayer (hereinafter referred to as the "transferor")

• has been transferred inter vivos to:

and the subsection 73(1) rollover rule has applied; or

• has been transferred or distributed, as a consequence of the transferor's death, to his or her spouse or common-law partner or to a spousal or common-law partner trust, and the subsection 70(6) rollover rule has applied.

If the spouse or common-law partner, former spouse or common-law partner, spousal or common-law partner trust, joint spousal or common-law partner trust, or alter ego trust (hereinafter referred to as the "transferee") subsequently disposes of the property, subsection 40(4) can apply with respect to a principal residence exemption, claimed by the transferee, for the property. For purposes of the transferee's claiming the principal residence exemption under either paragraph 40(2)(b) (see the formula in ¶ 8) or paragraph 40(2)(c) (see ¶s 20 to 23), the following rules apply under subsection 40(4):

Any year included in the period described in (a) is included by the transferee in variable C (the denominator of the fraction) in the formula in ¶ 8. Any year described in (b) is included by the transferee in variable B (the numerator of the fraction) in the formula in ¶ 8 or in the years included in the statement in ¶ 22(b), as the case may be, assuming that the transferee meets the residence requirement mentioned therein, as the case may be, for that year. (If the transferee is a trust, see (c) above with regard to this residence requirement.)

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Example 1

Mr. X was the sole owner of a house in Canada, which he had acquired in 1985. In 1990, Mr. X got married and his spouse, Mrs. X, moved into the house with him. In 1995, Mr. X died and the house was transferred to a spousal trust for Mrs. X. The trust was a trust as described in subsection 70(6). The trust's taxation year-end was December 31. If Mr. X had not died (and if he had sold his house in 1995), he could have designated it as his principal residence for any of the years 1985 to 1995 inclusive.

Under the rollover rule in subsection 70(6), Mr. X was deemed to have disposed of the house immediately before his death for proceeds equal to his cost of the house. Thus, Mr. X had no gain or loss on the deemed disposition of the house. The spousal trust for Mrs. X was deemed under subsection 70(6) to have acquired the house, at the time of Mr. X's death, at a cost equal to Mr. X's deemed proceeds, i.e., at Mr. X's cost of the house.

In 2001, Mrs. X died and the trust sold the house at fair market value. Since this amount was greater than the trust's deemed cost of the house, the trust had a "gain otherwise determined" from the disposition, which the trust (i.e., its trustee) wishes to eliminate by using the principal residence exemption.

Subsection 40(4) deems the trust to have owned the house in all the years in which Mr. X owned it, i.e., 1985 to 1995 inclusive, in accordance with the rule described in (a) above. (The house was, of course, owned by the trust in 1995 in any event.) This means that the years that the trust must include in variable C (the denominator of the fraction) in the principal residence exemption formula in ¶ 8 are 1985 to 2001 inclusive.

Since the trust is a personal trust resident in Canada and also since Mrs. X lived in the house and qualified as a specified beneficiary of the trust for the years 1995 to 2001 inclusive (see ¶ 35), the trust can designate the house as its principal residence for those years. The trust cannot designate the house as its principal residence for the years 1985 to 1994 inclusive; however, such a designation by the trust is not necessary – the house is already deemed by subsection 40(4) to have been the trust's principal residence for those years, in accordance with the rule described in (b) above, because Mr. X could have designated the house as his principal residence for those years. Also, in accordance with the rule described in (c) above, the trust is deemed to have been resident in Canada for the years 1985 to 1994 because Mr. X was resident in Canada during those years. Therefore, the trust is able to include all of the years from 1985 to 2001 inclusive in variable B (the numerator of the fraction) in the formula in ¶ 8. In other words, the trust is able to use the principal residence exemption formula in ¶ 8 to completely eliminate the gain otherwise determined on its disposition of the house in 2001.

Example 2

Assume all the same facts as in Example 1, except the following: Mr. X could not have designated the house as his principal residence for the years 1985 to 1988 inclusive because he had already designated his cottage (see ¶s 3 and 5) as his principal residence for those years (see the designation rules discussed in ¶ 6). Under these circumstances, the house that was transferred to the spousal trust for Mrs. X cannot be deemed to have been the principal residence of the trust for the years 1985 to 1988 inclusive. Therefore, the trust can only partially eliminate the gain otherwise determined on its disposition of the house in 2001 by means of the principal residence exemption formula in ¶ 8.

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In the case of an inter vivos transfer of property under subsection 73(1) of the Act, the following should be noted for purposes of any subsequent disposition of the property by the transferee:

• A designation of the property as the principal residence of the transferor – for one or more years prior to the transfer – may be needed in order for the property to be deemed to have been the principal residence of the transferee for those years by means of subsection 40(4) (see (b) above). Note that the transferor will not be able to designate the property as a principal residence for any particular year if another property is designated as a principal residence for that year by the transferor (or, if the year is after the 1981 taxation year, by the transferor or any of the other members of the transferor's family unit) – see ¶ 6. If the transferor is able to, and does in fact, designate the property as his or her principal residence for one or more years prior to the transfer, this does not necessarily mean that the transferor must actually file the designation form with the return for the year of the transfer (although the transferor may do so) – for further comments on the necessity to file a designation form, see ¶ 7. The transferor should, in any event, complete the designation form and, if it is not filed by the transferor, it should be retained by the transferee. Subsequently, if the transferee disposes of the property (or grants an option to another person to acquire the property) and wishes to use the principal residence exemption, the transferee would need to file the designation forms – i.e., the transferee's designation form for any years for which the transferee is designating the property as a principal residence and the transferor's designation form for any years for which his or her designation of the property causes the property to be deemed to have been the principal residence of the transferee

• Any taxable capital gain of the transferee (excluding an alter ego trust) from the disposition of the property or substituted property (which might occur, for example, because the transferee was not able to completely eliminate the gain otherwise determined by means of the principal residence exemption) could be deemed to be the taxable capital gain of the transferor by virtue of the attribution rules in section 74.2 of the Act. For a discussion of these rules, see the current version of IT-511, Interspousal and Certain Other Transfers and Loans of Property.

Partnership Property

¶ 39. Although a housing unit, a leasehold interest therein, or a share of the capital stock of a co-operative housing corporation (see ¶ 3) can be a partnership asset, a partnership is not a taxpayer and it cannot use the principal residence exemption on the disposition of any such property. However, a member of the partnership could use the principal residence exemption to reduce or eliminate the portion of any gain on the disposition of the property which is allocated to that partner pursuant to the partnership agreement, provided that the other requirements of the section 54 definition of "principal residence" are met (e.g., if the partner resides in the partnership's housing unit, this would satisfy the "ordinarily inhabited" requirement discussed in ¶ 5).

A Principal Residence Outside Canada

¶ 40. A property that is located outside Canada can, depending on the facts of the case, qualify as a taxpayer's principal residence (see the requirements discussed in ¶s 2 to 6). A taxpayer that is resident in Canada and owns such a qualifying property outside Canada during a particular taxation year can designate the property as a principal residence for that year in order to use the principal residence exemption (see ¶ 8 for the meanings of "resident in Canada" and "during"). Should a non-resident of Canada who owns a property outside Canada become a resident of Canada at any particular time, the provisions of the Act normally apply to deem that person to acquire the property at that time at fair market value, thereby ensuring that any unrealized gain on the property accruing to that time will not be taxable in Canada. Thereafter, the comments in the first two sentences of this paragraph may apply.

Non-Resident Owner of a Principal Residence in Canada

¶ 41. It may be possible for a property in Canada that is owned in a particular taxation year by a non-resident of Canada to qualify as the non-resident's principal residence (i.e., satisfy all the requirements of the section 54 definition of "principal residence" for the non-resident) for that year. The non-resident's spouse could be the one, for example, who satisfies the "ordinarily inhabited" rule – see ¶ 5 (or, alternatively, a subsection 45(2) or (3) election could make the designation of the property as the non-resident's principal residence possible – see ¶s 26 and 29). However, the use of the principal residence exemption by a taxpayer is limited by reference to the number of taxation years ending after the acquisition date during which the taxpayer was resident in Canada – see ¶s 8 and 22 (as indicated in ¶ 8, "during" a year means at any time in the year). Thus, even if a property in Canada owned by a non-resident qualifies as the non-resident's principal residence, the above-mentioned "residence in Canada" requirement typically prevents the non-resident from using the principal residence exemption to eliminate a gain on the disposition of the property.

¶ 42. In spite of the limitation mentioned in ¶ 41 in connection with the principal residence exemption, an election under subsection 45(2) or (3) could allow a non-resident owning a property in Canada to defer a taxable capital gain which would otherwise result from a deemed disposition of a property on a change in its use (see ¶s 25 and 28).

¶ 43. Where a non-resident owner of a property in Canada has rented out the property in a particular taxation year and has filed a subsection 45(2) or (3) election in respect of the property, see ¶s 25 and 28 regarding the restrictions on claiming CCA. These restrictions apply where the non-resident elects to report the rental income under section 216. (That election is discussed in the current version of IT-393, Election re Tax on Rents and Timber Royalties – Non-Residents.)

Section 116 Certificate for a Disposition of a Principal Residence in Canada by a Non-Resident Owner

¶ 44. Where a non-resident wishes to obtain a certificate under section 116 of the Act for a property in Canada which the non-resident proposes to dispose of or has disposed of within the last 10 days, a prepayment on account of tax must be made or security acceptable to the CCRA must be given before the certificate will be issued. Form T2062, Request by a Non-Resident of Canada for a Certificate of Compliance Related to the Disposition of Taxable Canadian Property, or a similar notification, must be filed in connection with a request for a section 116 certificate. Further particulars regarding the above are contained in the current version of Information Circular 72-17, Procedures Concerning the Disposition of Taxable Canadian Property by Non-Residents of Canada – Section 116. Where part or all of any gain otherwise determined on the disposition of the property by the non-resident is or will be eliminated by the principal residence exemption, the amount of prepayment on account of tax to be made or security to be given may be reduced accordingly. An application for such a reduction should be made by means of a letter signed by the taxpayer and attached to the completed Form T2062 or similar notification. Such letter should contain a calculation of the portion of the gain otherwise determined that is or will be so eliminated by the principal residence exemption.

Appendix A – Illustration of the Rule in Subsection 40(6)

If a taxpayer disposes (or is deemed to dispose) of a property which the taxpayer has owned (whether jointly with another person or otherwise) continuously since before 1982, the rule in subsection 40(6) (see ¶ 12) provides that the gain calculated under the usual method, using the principal residence exemption formula in ¶ 8, cannot be greater than the maximum total net gain determined under an alternative method. Under the alternative method, there is a hypothetical disposition on December 31, 1981 and reacquisition on January 1, 1982 of the property at fair market value (FMV). The maximum total net gain determined under the alternative method is then calculated as follows:

pre-1982 gain + post-1981 gain – post-1981 loss = maximum total net gain

where

• the pre-1982 gain is the gain (if any), as reduced by the principal residence exemption formula in ¶ 8, that would result from the hypothetical disposition at FMV on December 31, 1981,
• the post-1981 gain is the gain (if any), as reduced by the principal residence exemption formula in ¶ 8 without the "1 +" in the numerator "B" in that formula, that would result from the hypothetical acquisition at FMV on January 1, 1982 and the subsequent actual (or deemed) disposition, and
• the post-1981 loss is the amount of any loss that has accrued from December 31, 1981 to the date of the subsequent actual (or deemed) disposition, i.e., the excess (if any) of the FMV on December 31, 1981 over the proceeds (or deemed proceeds) from the subsequent actual (or deemed) disposition.

The examples which follow illustrate the rule in subsection 40(6). It has been assumed in these examples that, on each actual disposition, no costs were incurred in connection with that disposition.

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Example 1

Mrs. X acquired a house in 1975 for $50,000. She and her husband lived in it until February 1996, when she sold it for $115,000, resulting in an actual gain of $65,000 ($115,000 – $50,000). Ever since the sale of the house in 1996, Mr. and Mrs. X have been living in rented premises. In filing her 1996 income tax return, Mrs. X designated the house as her principal residence for 1975 to 1995 inclusive, and thus her gain otherwise determined was completely eliminated by the principal residence exemption formula in ¶ 8:

Gain otherwise determined ($115,000 – $50,000)	$65 000
Reduce by principal residence exemption: A × (B ÷ C) = $65,000 × [1 + 21 (1975 to 1995)] ÷ [22 (1975 to 1996)]	65,000
Gain	$     NIL

Mr. X acquired a lot in 1975 for $7,000 and built a cottage on it in 1979 for $13,000. Mr. and Mrs. X used the cottage as a seasonal residence from 1979 to 2001 inclusive. In the fall of 2001 Mr. X sold the cottage for $65,000, resulting in an actual gain of $45,000 ($65,000 – ($7,000 + $13,000)). In filing his 2001 income tax return, Mr. X designated the cottage property as his principal residence for 1979 to 1981 inclusive, as well as for 1996 to 2001 inclusive. He could not designate the property as his principal residence for 1975 to 1978 inclusive because it was only a vacant lot and thus no one "ordinarily inhabited" it in those years (see ¶ 11); nor could he designate the property as his principal residence for 1982 to 1995 inclusive because of his wife's designation of the house as her principal residence for those years (see ¶ 6). As a result, not all of his $45,000 gain otherwise determined was eliminated by the principal residence exemption formula in ¶ 8. However, because the property had been owned by Mr. X continuously since before 1982, subsection 40(6) applied for purposes of computing his gain. The fair market value of the cottage on December 31, 1981 was $30,000.

In addition to the above facts, assume also that Mr. X did not make a subsection 110.6(19) capital gains election with respect to the cottage (see the discussion of this election in ¶ 8) because he had already used up his $100,000 lifetime capital gains exemption before 1994. Therefore, he had no capital gains election reduction amount (as described in ¶ 8) with respect to the cottage.

The calculations under subsection 40(6) in connection with Mr. X's 2001 gain on the cottage were as follows:

USUAL METHOD FOR CALCULATING GAIN:

Gain otherwise determined ($65,000 – $20,000)	$45,000
Reduce by principal residence exemption: A × (B ÷ C) = $45,000 × [1 + 9 (1979 to 1981 and 1996 to 2001)] ÷ [27 (1975 to 2001)]	16,667
Gain	$28,333

ALTERNATIVE METHOD – CALCULATION OF MAXIMUM TOTAL NET GAIN:

Pre-1982 gain:

Gain otherwise determined ($30,000 – $20,000)	$10,000
Reduce by principal residence exemption: A × (B ÷ C) = $10,000 × [1 + 3 (1979 to 1981)] ÷ [7 (1975 to 1981)]	5,714
Gain	$4,286

Post-1981 gain:

Gain otherwise determined ($65,000 – $30,000)	$35,000
Reduce by principal residence exemption: A × (B ÷ C) = $35,000 × [6 (1996 to 2001)] ÷ [20 (1982 to 2001)]	10,500
Gain	$24,500

Post-1981 loss:

N/A	$  NIL
Pre-1982 gain + post-1981 gain – post-1981 loss
= $4,286 + $24,500 – $Nil = $28,786.

RESULT: Mr. X's gain remained at the $28,333 calculated under the usual method since that amount did not exceed the maximum total net gain of $28,786 calculated under the alternative method.

Example 2

Assume the same facts in Example 1 except that the couple are in a common-law relationship rather than a married couple.

In filing his 2001 income tax return, Mr. X designated the cottage property as his principal residence for 1979 to 1992 inclusive, as well as for 1996 to 2001 inclusive. He could not designate the property as his principal residence for 1975 to 1978 inclusive because it was only a vacant lot and thus no one "ordinarily inhabited" it in those years (see ¶ 11); nor could he designate the property as his principal residence for 1993 to 1995 inclusive because of his common-law partner's designation of the house as her principal residence for those years (see ¶ 6). As a result, not all of his $45,000 gain otherwise determined was eliminated by the principal residence exemption formula in ¶ 8.

The calculations under subsection 40(6) in connection with Mr. X's 2001 gain on the cottage were as follows:

USUAL METHOD FOR CALCULATING GAIN:

Gain otherwise determined ($65,000 – $20,000)	$45,000
Reduce by principal residence exemption: A × (B ÷ C) = $45,000 × [1 + 20 (1979 to 1992 and 1996 to 2001)] ÷ [27 (1975 to 2001)]	35,000
Gain	$10,000

ALTERNATIVE METHOD – CALCULATION OF MAXIMUM TOTAL NET GAIN:

Pre-1982 gain:

Gain otherwise determined ($30,000 – $20,000)	$10,000
Reduce by principal residence exemption: A × (B ÷ C) = $10,000 × [1 + 3 (1979 to 1981)] ÷ [7 (1975 to 1981)]	5,714
Gain	$ 4,286

Post-1981 gain:

Gain otherwise determined ($65,000 – $30,000)	$35,000
Reduce by principal residence exemption: A × (B ÷ C) = $35,000 × [17 (1982 to 1992 and 1996 to 2001)] ÷ [20 (1982 to 2001)]	29,750
Gain	$ 5,250

Post-1981 loss:

N/A	$  NIL
Pre-1982 gain + post-1981 gain – post-1981 loss
= $4,286 + $5,250 – $Nil = $9,536

RESULT: Although Mr. X's gain calculated under the usual method was $10,000, such gain could not exceed the maximum total net gain of $9,536 calculated under the alternative method. Therefore, the gain was reduced to $9,536.

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Appendix B – Illustration of Calculation of Gain on Disposition of a Farm Property

Assume that a taxpayer resident in Canada sold a 50 hectare farm. The taxpayer owned the farm and occupied the house on it from July 30, 1993 to June 15, 2001. The house and one-half hectare of the land have been designated as the taxpayer's principal residence for the 1993 to 2001 taxation years inclusive. The taxpayer's calculations of the gain on the disposition of the farm property, using the two methods permitted by paragraph 40(2)(c) of the Act, are as follows:

FIRST METHOD (see ¶ 21)

	Principal Residence	Farm	Total Property
Proceeds of disposition
Land	$10,000*	$90,000	$100,000
House	50,000	–	50,000
Barn	–	35,000	35,000
Silo	–	15,000	15,000
	$60,000	$140,000	$200,000
Adjusted cost base
Land	$2,000*	$58,000	$60,000
House	20,000	–	20,000
Barn	–	11,000	11,000
Silo	–	4,000	4,000
	$22,000	$73,000	$95,000
Gain otherwise determined	$38,000	$67,000	$105,000
Less: Principal residence exemption	38,000	–	38,000
Gain	$    NIL	$67,000	$67,000

* Since the principal residence portion of the land is 1/100 of the total land (i.e., one-half hectare divided by 50 hectares), one way (as described in ¶ 21(a)) of assigning values to the principal residence portion of the land would be to simply use $1,000 (i.e., 1/100 of $100,000) for the proceeds for such portion of the land and $600 (i.e., 1/100 of $60,000) for the adjusted cost base of such portion. Assume, however, that a typical residential lot in the area, although less than one-half hectare in this example, had a fair market value of $10,000 as of the date of sale and $2,000 as of the date of acquisition. As indicated in ¶ 21(b), we would accept the taxpayer's use of the latter amounts, which in this case would result in a greater portion of the gain otherwise determined being eliminated by the principal residence exemption.

SECOND METHOD (see ¶ 22)

Proceeds of disposition for total farm property			$200,000
Adjusted cost base for total farm property			95,000
Gain otherwise determined			$105,000
Less: Principal residence exemption using subparagraph 40(2)(c)(ii) election: $1,000 + (9 × $1,000)			10,000
Gain			$ 95,000

RESULT: In this example, the first method results in a lower gain to the taxpayer.

Explanation of Changes

Introduction

The purpose of the Explanation of Changes is to give the reasons for the revisions to an interpretation bulletin. It outlines revisions that we have made as a result of changes to the law, as well as changes reflecting new or revised CCRA interpretations.

Reasons for the Revision

This bulletin is being revised to reflect legislative changes enacted under S.C. 2000, c.12 (formerly Bill C-23) and S.C. 2001, c.17 (formerly Bill C-22). The comments in the bulletin are not affected by any proposed legislation released before June 9, 2003.

Legislative and Other Changes

The bulletin has been revised to reflect the repeal of subsection 252(4) and the addition of the term "common-law partner" to the Act. Specific discussions on this topic have been added to ¶s 2 and 6 of the bulletin.

The discussion in former ¶ 12 on spousal trusts and subsection 107(4) has been removed since paragraph 104(4)(a) now also refers to joint spousal or common-law partner trusts and alter ego trusts. A discussion on these types of trusts and the application of subsection 107(4) to these trusts is outside of the scope of this bulletin. The remainder of former ¶ 12 has been moved to ¶ 36.

We have added a comment in ¶ 15 regarding recreational or lifestyle uses for land in excess of one-half hectare.

¶ 17 has been expanded to clarify the CCRA's interpretation. The previous version contemplated that a taxpayer would subdivide and immediately sell the newly created lots. Comments have been added to also address the situation where a taxpayer subdivides his or her property but then holds the lots for a period of time.

¶ 38 (formerly ¶ 36) now addresses the rules in subsection 40(4) as they relate to alter ego trusts and joint spousal and common-law partner trusts by virtue of their addition to the list of qualifying transfers set out in new subsection 73(1.01) of the Income Tax Act. Specific references to spousal trusts have been removed from ¶ 38 as the rules now apply to the aforementioned trusts as well.

The various examples in the bulletin and its appendices have been updated to reflect more current years and current law.

Throughout the bulletin, we have made other changes for clarification or readability purposes, and we have deleted items which were redundant or which no longer have any relevance.

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Notice—Bulletins do not have the force of law

At the Canada Customs and Revenue Agency (CCRA), we issue income tax interpretation bulletins (ITs) in order to provide technical interpretations and positions regarding certain provisions contained in income tax law. Due to their technical nature, ITs are used primarily by our staff, tax specialists, and other individuals who have an interest in tax matters. For those readers who prefer a less technical explanation of the law, we offer other publications, such as tax guides and pamphlets.

While the comments in a particular paragraph in an IT may relate to provisions of the law in force at the time they were made, such comments are not a substitute for the law. The reader should, therefore, consider such comments in light of the relevant provisions of the law in force for the particular taxation year being considered, taking into account the effect of any relevant amendments to those provisions or relevant court decisions occurring after the date on which the comments were made.

Subject to the above, an interpretation or position contained in an IT generally applies as of the date on which it was published, unless otherwise specified. If there is a subsequent change in that interpretation or position and the change is beneficial to taxpayers, it is usually effective for future assessments and reassessments. If, on the other hand, the change is not favourable to taxpayers, it will normally be effective for the current and subsequent taxation years or for transactions entered into after the date on which the change is published.

Most of our publications are available on our Web site.

If you have any comments regarding matters discussed in an IT, please send them to:

or by email at the following address: bulletins@ccra.gc.ca

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