Using Your Child’s Principal Residence Exemption: A Strategic Approach 

The Principal Residence Exemption (PRE) is a powerful tax benefit that allows Canadian homeowners to sell their homes without incurring capital gains tax. While it may seem advantageous to transfer property to a child to maximize this exemption, doing so comes with significant risks and tax implications. This article explores the potential pitfalls of gifting a home to a young child and an alternative strategy using a trust to preserve tax benefits. 

Why Gifting a Home to a Child Is Not a Good Idea 

Parents may consider gifting a home to their child to take advantage of the child’s separate family unit for PRE purposes. However, this strategy presents several risks: 

1. Loss of Control – Once the property is transferred, the child has full ownership and can sell, rent, or use the property as they please, regardless of the parents’ wishes. 
2. Financial Responsibility – Many young individuals may not have the financial discipline to manage property-related expenses, such as maintenance, property taxes, and insurance. 
3. Family Law Implications – If the child later gets married and the spouse uses the property, the property may become subject to division upon separation. 

Given these concerns, using another vehicle like a trust may provide a more controlled and tax-efficient approach to holding property for the benefit of a child. 

Using a Trust to Buy a Property 

A trust can be used to acquire and hold a property while still allowing a beneficiary (e.g., a child) to use the home. The trust has these key advantages: 

1. Preserving Control – The trust, rather than the child, owns the home, ensuring that parents or trustees maintain decision-making authority over its use and disposition.
2. Avoiding Immediate Capital Gains Tax – When properly structured, the trust can defer capital gains tax until it reaches its 21-year anniversary. But there is tax planning to consider to transfer the property to a beneficiary who can continue to hold it and defer taxes.
3. Avoiding Taxable Benefit on Personal Use – Historically, if a beneficiary lived in a trust-owned home, they were considered to receive a taxable benefit (meaning they will be taxed in accordance with their personal use) according to 105(1) of the Income Tax Act. However, the CRA has stated that it will generally not apply this rule, allowing beneficiaries to live in the home without triggering additional tax liabilities. 

Transferring Property from a Trust to a Beneficiary 

One key advantage of using a trust is the ability to transfer the trust’s property to a beneficiary (under section 107(2) of the Income Tax Act (ITA). The roll out the property should generally happen before reaching the 21-year deemed disposition rule. This is explained later in this article). The beneficiary is deemed to have owned the property from the time the trust originally acquired it (s. 40(7) of the ITA). 

This means so long as the beneficiary (which is the adult child in this case) ordinarily inhabited the property during the years it was owned by the trust, it should meet the principal residence requirements, and the property should qualify for the PRE for the entire period the trust owned the home. This would result in significant tax savings upon a future sale! 

Potential Drawbacks of Using a Trust 

While the trust strategy offers many advantages, there are a few considerations:  

1. First Home Savings Account (FHSA) Restrictions – A beneficiary using this approach may not be able to take advantage of the FHSA, which provides tax-free savings for first-time homebuyers. 
2. Land Transfer Tax Implications – Transferring a property to a trust or from a trust to a beneficiary may trigger land transfer tax, depending on provincial rules. This will depend on the specific jurisdiction’s laws. In Ontario, land transfer tax is generally based on ‘consideration’ paid for the property and there is no consideration when there is a roll-out which suggests there should be no land transfer tax. 
3. 21 Year Rule – A trust is deemed to sell everything and reacquire it on its 21st anniversary. That means the trust pays capital gains on the full appreciation over the 21 years. While this is not ideal, it can be managed as the trust’s property can be transferred or ‘rolled-out’ to the beneficiaries of the trust just prior to that anniversary. The beneficiary will inherit the property with the trust’s cost and the beneficiary will pay capital gains only when they sell.  

Conclusion 

While gifting a home to a child to maximize the Principal Residence Exemption may seem appealing, it comes with risks and potential unintended consequences. Using a trust to acquire and hold the property can provide better control while still preserving the ability to claim the PRE when structured correctly. Before implementing such strategies, seeking professional tax and legal advice is crucial to ensure compliance with tax laws and to minimize unintended liabilities. 

If you have any questions about you buying a second home or a home for your children, you can contact the team at CoPilot Tax here. Working with us can help you navigate these complexities.