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Saturday, January 14, 2012

The Principal-Residence Exemption and Excess Land

The Principal-Residence Exemption and Excess Land

The capital gain arising on a disposition of a "principal residence" (defined in section 54 of the Act) is reduced or eliminated by the amount of the exemption calculated under the formula in paragraph 40(2)(b). The principal residence of a taxpayer for a taxation year is deemed to include the land on which the housing unit sits and the portion of the immediately contiguous land that can reasonably be regarded as contributing to the use and enjoyment of the housing unit as the residence. If the total area of the subjacent land and the immediately contiguous land exceeds one-half hectare, the excess land is deemed not to be part of the principal residence unless the taxpayer establishes that the excess land was necessary to the use and enjoyment of the housing unit as a residence.

In Cassidy v. Canada (2011 FCA 271), the issue was whether the excess land formed part of the taxpayer's principal residence. The taxpayer and his common-law spouse acquired a house on 2.43 hectares of land in 1994. The taxpayer became the sole owner of the property in 1998, and he resided in the house on the property from 1994 until 2003, when the property was sold.

At the time that the taxpayer acquired the property, he could not acquire less than the 2.43-hectare parcel because of the applicable zoning laws. From May 2003 onward, he could have applied for a rezoning and subdivision of the property by virtue of an official plan amendment that came into force at that time. On May 23, 2003, the taxpayer entered into an agreement of purchase and sale of the property subject to certain conditions for the benefit of the purchaser, including a successful application for rezoning and subdivision. All conditions were satisfied, and the sale closed on November 27, 2003.

The taxpayer did not report a gain in his 2003 income tax return on the basis that the entire gain qualified for the principal-residence exemption. The CRA reassessed the taxpayer on the basis that the excess land did not qualify for the exemption. The TCC (2010 TCC 471), relying on Stuart Estate v. The Queen (2003 DTC 329 (TCC), aff'd. 2004 DTC 6173 (FCA) and The Queen v. Yates (83 DTC 5158 (FCTD), aff'd. 86 DTC 6296 (FCA), dismissed the taxpayer's appeal on the basis that the time for determining whether the excess land was necessary for the use and enjoyment of the property was the time of disposition or immediately before the disposition. Favreau J held that at the time of sale or immediately before, the minimum lot size in the area was 850 square metres, and the taxpayer was not prohibited from subdividing his property and disposing of any portion of it.

On appeal, the FCA analyzed the formula in paragraph 40(2)(b). Under that formula, the exempt portion of the gain is A × B/C, where A is the amount of the gain, B is 1 plus the number of taxation years that end after the purchase date for which the property was the taxpayer's principal residence and during which the taxpayer is resident in Canada, and C is the number of taxation years of property ownership by the taxpayer.

The FCA held that variable B requires that for each taxation year in which the property was owned by the taxpayer, one must determine whether the property met the definition of "principal residence." The court held that when the issue is whether the excess land is part of the principal residence, the formula should be applied in two stages: first to the portion of the gain allocable to the house and the one-half hectare of land, and then to the portion of the gain allocable to the excess land. Using the two-stage process, the court determined that the entire gain allocable to the house and one-half hectare of land was entirely exempt, as was the gain allocable to the excess land. With respect to the excess land, the court held that it qualified for the principal-residence exemption for 1994 to 2002; the court did not reach a conclusion with respect to 2003. Therefore, variable B was 10 and no capital gain arose with respect to the excess land.

In allowing the appeal, Sharlow JA considered or commented on several earlier cases, including Stuart Estate and Yates, which were distinguished on the basis that the facts relevant to the application of the one-half hectare rule had not changed during the period of ownership.

Cassidy is a welcome decision and changes our understanding of how the principal-residence exemption is determined. The determination is now made on an annual basis, and if excess land is involved, the two-stage method is to be used.

Philip Friedlan
Friedlan Law
Toronto and Richmond Hill, ON

via ctf.ca