Principal Residence: When Civil Law Muddles Tax Law

The notion of "principal residence" is an important concept in tax law. Under the Act, a taxpayer may be exempt from a capital gain resulting from the disposition of a principal residence. Even though section 54 defines the term "principal residence," Quebec private law complicates its application. Indeed, the right of ownership may be dismembered into usufruct, use, servitude, and emphyteusis under articles 1119 et seq. of the Civil Code of Québec (CCQ). Let us assume that one of these dismemberments applies to a property "ordinarily inhabited" within the meaning of "principal residence" in section 54. Suppose that a widow with a usufruct lives in the principal residence, but the bare (or legal) ownership belongs to the children. The value appreciates, and a disposition (deemed by death or an actual sale) occurs. Can each of the two parties claim an exemption for the capital gain?

For federal income tax purposes, the answer is normally yes. This conclusion is based on a reading of clause 248(3)(a)(i)(A) of the Act, which stipulates that "the usufruct, right of use or habitation, or substitution, as the case may be, is deemed to be at that time a trust," and of paragraph (c.1) of the definition of "principal residence" in subsection 54, which states that a trust may designate a property as its principal residence.

Federal income tax rules may give a different answer in the special case of usufructs created before 1991. Usufructs were deemed trusts under paragraph 248(3)(a) beginning in 1991; therefore, how does one characterize usufructs created prior to the amendments? (Under the former rules, an immovable could not be transferred to a trust.) In the absence of a deemed trust, one must refer to the applicable definitions. Under the CCQ, the usufructuary does not own the property, but possesses a real right of enjoyment (similar but not equivalent to the common-law concept of beneficial ownership). Under the definition of "principal residence," the individual must be the owner. This contradiction raises the question of how a pre-1991 usufruct can qualify as a principal residence.

The CRA interprets the pre-amendment rules under paragraph 248(3)(a) as follows: the property is not transferred to a trust, but the usufructuary is considered the de facto owner of the immovable. Therefore, the usufructuary is the only person entitled to claim the principal residence exemption when the property is sold (CRA document no. 2009-0310751I7, May 27, 2009). But how is the value broken down between the usufruct and the bare ownership? More specifically, does section 69 apply when the two individuals who hold rights are related within the meaning of the Act, but only one of those rights appears to qualify for the exemption? As far as can be ascertained, these questions remain unanswered.

The answer to the dismemberment question regarding the principal residence exemption is less clear for Quebec provincial income tax purposes. Revenu Québec's view is that the usufructuary may claim the principal residence exemption only "where this application does not result in any unreasonable tax consequence" (Interpretation Letter 10-009700-001, April 19, 2011) (my translation). A request has been filed with Revenu Québec asking for a technical interpretation of the circumstances in which such an application would not result in any unreasonable tax consequences.

Marjorie Bergeron
De Chantal D'Amour Fortier S.E.N.C.R.L./LLP
Longueuil, QC

Canadian Tax Focus
Volume 3, Number 2, May 2013
©2013, Canadian Tax Foundation