On October 3, 2016, the Federal government announced several changes affecting the reporting of any sale of real estate and the tax exemption for a principal residence.

It is quite common for an individual to assume that the gain on the sale of their family home is simply tax exempt and therefore, there is no need to report such disposition in their personal income tax return.

However, the Income Tax Act, actually requires an individual to claim an exemption in computing the amount of their gain that is subject to tax. The tax exempt portion of a gain is based upon a formula. The numerator in the formula is computed by reference to 1 plus the number of years that the property meets the definition as a "principal residence" while a resident of Canada and is so designated for each year. The denominator is equal to the number of years of ownership. The "1+ rule" is intended to provide coverage for the sale of an old principal residence and the purchase of a new principal residence in the same year.

Under the formula, if a property qualifies as a principal residence for every year of ownership, then the entire gain on sale will be tax exempt provided a prescribed Form T2091 designating the property accordingly is filed with the Canada Revenue Agency ("CRA") along with individual's personal tax return for the year in which the principal residence is sold.

Subject to certain conditions, where a trust realizes a gain on the sale of a property ordinarily inhabited by a beneficiary, the trust may also take advantage of the tax exemption for a principal residence provided it duly files a Form T1079 designating the property accordingly along with its T3 trust income return for the year in which the residence is sold.

It has been the CRA's long standing administrative policy that an individual need not file a Form T2091 if the principal residence exemption eliminated their entire gain from taxation. No similar relief has been granted to a trust. Arguably, the CRA's administrative policy has contributed to the general assumption that a family home or principal residence is subject to a blanket tax exemption.

So what are the latest changes?

In brief terms, the tax changes relating to the disposition of real estate are as follows:

1. The principal residence formula is changing (effective for dispositions after October 3, 2016) so that the extra 1 year in the numerator is only available where an individual was a resident of Canada in the year the residence was acquired. This change is intended to prevent a non-resident purchaser who later becomes a resident of Canada from diluting the portion of their gain subject to taxation by benefiting from the 1+ rule.
2. Starting with the 2016 tax year, the CRA will require an individual to report the sale of their principal residence and designate it accordingly in Schedule 3 of their personal income tax return if the property qualified as a principal residence for each year of ownership. Schedule 3 will be modified for the new reporting requirements. In addition, Form T2091 (or Form T1255 in the case of a deceased individual) will continue to only be required to be filed along with a personal income tax return where a residence was not a principal residence for all years of ownership and consequently, part of the gain on sale is subject to tax.
3. The Income Tax Act will be amended to provide for the late filing of the prescribed forms for a principal residence designation for a period up to 10 years. It should be noted that a late filing will be subject to a penalty equal to $100 per complete month that the election is late up to a maximum penalty of $8,000.
4. In the case of a trust making a principal residence designation for any taxation year after 2016, such designation will be restricted to a spousal trust, alter or joint alter ego trust, a qualifying disability trust or a trust for the benefit of a minor child of a deceased parent.
5. For taxation years ending after October 3, 2016, the CRA will have the power to reassess tax on an unreported disposition of real estate for an unlimited period. Accordingly, the CRA will not have to demonstrate gross negligence to reassess tax in the case of an unreported disposition of real estate for a taxation year that is otherwise statute-barred. In the case of real estate disposed of by a partnership or corporation, this new rule will be restricted to real estate that is held as capital property, the gain on which sale is treated as a capital gain.

So what does this all mean?

Commencing with the 2016 taxation year, an individual (or a couple in the case of a jointly owned property) will need to report the disposition of their principal residence and make the requisite principal residence designation in Schedule 3 of their personal income tax return where the property qualified as a principal residence for every year of ownership to ensure that the entire gain on sale is treated as a tax exempt gain.

For 2016 and later years, all dispositions of real estate should be reported by an individual to the CRA, including the sale of a cottage or principal residence at a loss (despite no tax write-off being permitted) in order to limit CRA's ability to reassess tax owing on a sale to the normal 3-year period from the date of the initial notice of assessment.

Where a principal residence is held by an inter vivos family trust or self-interest trust (typically for succession planning and/or avoidance of probate fees purposes), its trustees should consult with their tax advisors as to the tax implications of the trust ceasing to be entitled to designate the residence as a principal residence for any years of ownership after 2016.