Effect on a Beneficiary’s Right to Designate a Separate Property as a Principal Residence if Property Already Designated by an Alter Ego Trust
Sometimes when a widow has inherited the family home as a life tenant and eventually remarries she may want to change the way the family home is held in order to benefit her new spouse after her death. One option that is often considered is a transfer of the house to an alter ego trust (the “Trust”). The transfer of the house to Trust raises some potential tax issues. In particular, there is a concern that if the Trust designates the home as a principal residence the children as beneficiaries to the Trust might be precluded from designating their own homes as a principal residence.
Under the Income Tax Act (Canada) (the “Act”) an alter ego trust can designate a property as a principal residence, with certain exceptions. A trust is prevented from designating a property as a principal residence where a “specified beneficiary”, or a member of the specified beneficiary’s family unit, has already made the designation with respect to another property. A specified beneficiary is a person who was beneficially interested in a trust that designated a property as a principal residence and who ordinarily inhabited the home. A person may be beneficially interested in the home although they do not have an income or capital interest. It is the CRA’s view that an individual with a life interest would be considered beneficially interested in a trust that provided the use of the property.
Where the trust designates the property as its principal residence no other property can be designated as a principal residence by a member of the specified beneficiary’s family unit. A family unit includes the specified beneficiary’s spouse or common-law partner and children under 18 years old. The CRA has expressed the opinion that while a family unit does not generally include an adult child, or a married child, a parent who is beneficially interested in the trust but does not ordinarily inhabit the home will be treated as a specified beneficiary if the housing unit held by the trust is inhabited by the child of that individual regardless of the age or marital status of the child. This is intended to prevent an individual from making two principal resident designations where they are part of one family unit. In this situation, the parent or the trust can make a designation but not both.
The CRA has also provided further clarification in response to an issue that was raised about whether beneficiaries of a trust who do not reside at the home will be prohibited from designating their homes as their principal residence. The CRA’s view is that where a trust owns a property which is occupied by a life tenant the principal resident designation by the trust will not prevent capital beneficiaries from making a principal resident designation on the house where they reside, provided they do not live in the same house as the life tenant.
Therefore, it is likely that if an individual resides in the house with their new spouse and none of the children who are beneficially interested in the trust will reside there, in light of previous CRA published opinions on this issue, the trust will be entitled to designate the house as its principal residence without affecting the children’s ability to designate their own homes as their principal residence.