How Does The Principal Residence Exemption Affect Spouses

The Scenario

Two spouses each own property in only their name alone, and go back and forth between living in their respective properties together. These spouses are not each other’s primary beneficiaries. If one of the spouses passes away, leaving a Last Will and Testament which appoints a person other than their spouse as the executor of their estate, this could lead to a problem when the deceased spouse’s final tax return is filed. If the principal residence exemption (“PRE”) is claimed for the deceased spouse’s property for every year they owned it, this can have implications for the surviving spouse. Although claiming the PRE for every year the deceased spouse owned the property may mean that there would be no tax owing to the CRA on the capital gains from the appreciation of that property, this may not be the best course of action.

The Problem

This scenario can lead to a problem due to s.54 of the Income Tax Act (“ITA”). S.54 of the ITA states that there can only be one principal residence per family unit in a given tax year. This means that if the executor for the deceased spouse claims the PRE on their property, the other spouse will not be entitled to claim the PRE on their own property during that period. If the surviving spouse’s property appreciates in value, they would have to pay a capital gains tax to the CRA following the sale of their property or the tax would need to be paid by their estate upon their death. Thus, if the executor of the deceased spouse claims the PRE on their property, it could create a situation which unfairly precludes the surviving spouse from claiming the PRE on their own property. It should be noted that this section of the ITA also applies to common law partners. Under the ITA, common law partners are defined as people who cohabitate in a conjugal relationship for at least 12-months.

The Solution

There are steps which can be taken to prevent a person from being deprived the opportunity to claim the PRE on their property. People who are married or in a common law partnership and do not have common beneficiaries should consider entering into an agreement regarding the allocation of PRE years. An agreement would allow spouses to arrange for the PRE to be claimed between them in a manner which minimizes the aggregate amount taxed on the gain attributed to each of their properties and take into consideration other possible tax consequences. If an agreement of this nature exists, the executors and trustees of the deceased spouse’s estate should make decisions regarding the PRE in accordance with the agreement.