30 September 2011 Internal T.I. 2010-0387891I7 - Principal Residence

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: 1. Review of principal residence court cases

Position: 1. Facts and case law indicate the entire property was not necessary to the use and enjoyment of the housing unit as a principal residence.

Reasons: 1. Definition of principal residence.

Vancouver TSO			 				2010-038789
757 West Hastings Street
Vancouver BC  V3T 5E1						Robert Dubis
									(905) 721-5191

September 30, 2011

Dear XXXXXXXXXX :

Re: Principal Residence

This letter is in response to your correspondence dated November 23, 2010 regarding the application of the principal residence exemption to a specific audit case where a taxpayer has disposed of a residence and land which in total were XXXXXXXXXX acres (XXXXXXXXXX hectares) in size.

The audit section proposes to allow a principal residence designation for XXXXXXXXXX acres after giving consideration to the location of buildings on the property. The taxpayer asserts that the impossibility of subdivision at the time of sale entitles the taxpayer to the principal residence deduction for the entire parcel of land, notwithstanding the fact that the minimum zoning requirement was one acre.

You asked whether the property may be subdivided and what portion of the entire property qualifies for designation as the principal residence for the purposes of paragraph 40(2)(b) of the Income Tax Act (Act).

Whether a particular property may be subdivided, and if so, the basis upon which it may be subdivided is a question of fact. The role of the ITRD is to provide technical assistance with respect to the interpretation and application of the Act in general. In this regard, in light of the documents provided, we have taken a review of the legislation and jurisprudence pertaining to principal residences and provided comments on the application of the law which we hope will assist you in making a decision.

Legislation

A capital gain in respect of the disposition of a principal residence is calculated in accordance with paragraph 40(2)(b) of the Act. Where a disposition of a principal residence meets all the requirements, that paragraph allows a complete exemption for the gain on its disposition.

Section 54 of the Act contains a specific definition of "principal residence". It is a detailed definition, but for the purposes of our interpretation, the relevant elements of the law are contained in paragraph (e) of the definition which deems the excess land not to have contributed to the use and enjoyment of the housing unit as a residence. It has been determined by the courts that in the context of a principal residence, the burden of proof falls upon the taxpayer who contends that an area in excess of half a hectare of the subjacent land is necessary to the use and enjoyment of the housing unit as a residence.

The Agency's interpretation of the law where there is land in excess of 1/2 hectare is stated in paragraph's 15 and 16 of Interpretation Bulletin IT-120R6, Principal Residence. The bulletin recognizes the impact that various factors may have in determining whether the excess portion of land is necessary for the use and enjoyment of the housing unit as a residence.

In interpreting the words of the statute, in Rode vs. The Queen (TCC) (85 DTC 272), Christie J. considers the meaning of the words "necessary". In Todesco vs. The Queen (TCC) (99 DTC 1219), Teskey J. highlights the importance of the words "as a residence" in the definition of principal residence.

Based on a legislative requirement that the excess land must be "necessary to the use and enjoyment of the housing unit as a residence", we provide the following comments.

Background Information

The subject property was acquired by the taxpayer in 1968 and sold in 2006 to a purchaser identified as XXXXXXXXXX (XXXXXXXXXX ) ("the School Board"). Although the identified purchaser was the School Board, you ascertained during the course of our review that the contract of purchase and sale was in fact between the taxpayer and a developer. The developer assigned the contract of purchase and sale to the School Board and the documentation indicates that as a condition of assignment, the School Board optioned to the developer a XXXXXXXXXX acre portion of the assembly upon re-subdivision of the existing sites. At the same time the developer also assigned to the School Board a contract of purchase and sale for the adjacent property. You provided an independent appraisal of both properties prepared for the School Board. Finally, you ascertained that the developer or related persons acquired a total of XXXXXXXXXX additional properties in immediate proximity to the subject property in 2006 and 2007.

Taxpayers Position

Despite its one acre residential zoning at the time of sale, the taxpayer submits that it was unlikely that the property could be subdivided because it was part of a larger group of properties which would be designated for specific uses, such as XXXXXXXXXX .

To support of his position that the land was not sub-dividable, the taxpayer obtained from XXXXXXXXXX ("First Report") of the property in XXXXXXXXXX 2007. In responding to the audit section's position that most of the excess land did contribute to the use and enjoyment of the housing unit as a residence, the taxpayer provided a legal submission.

Each of these cases cited in the legal submission addresses the court's interpretation of the words "necessary to such use and enjoyment". Much of the jurisprudence dealing with the principal residence exemption refers to The Queen vs. Yates (FCA) (86 DTC 6296) because it established a framework for establishing the burden of proof necessary to claim the exemption under paragraph 40(2)(b) of the Act. Yates also established the concepts of an objective or subjective test for determining whether the excess land is necessary for the use and enjoyment as a principal residence.

Analysis

At this time, the taxpayers are relying primarily on objective tests for establishing that the excess land contributed to the use and enjoyment of the housing unit as a residence.

There is no comprehensive list or definition of what constitutes an "objective test". Under an objective test, a factor such as a zoning by-law which unquestionably states that a taxpayer cannot legally occupy his or her housing unit as a residence on less than a set minimum of acres or a specified frontage could establish the burden of proof. A zoning test formed the basis for the court decisions in Yates and Carlile vs. The Queen (FCA) (95 DTC 5483). In Sendher vs. The Queen (TCC) (98 DTC 1250) the frontal restriction prevented the severance of the lot into two saleable properties. In Brohman Estate vs. The Queen (TCC) (2001 DTC 71) the court concluded the entire parcel of land was used as a residence after considering how various elements of the property (frontage, topographical, geological), a local "10-acre freeze" and the requirement for an assemblage of other properties would be necessary to obtain subdivision approval. In Michael vs. The Queen (TCC) (85 DTC 455) the court relied primarily on a zoning test but also made reference to a "highest and best use" test after considering the set-back from the road, soil composition and character of the surrounding property.

Zoning Requirements

In Yates and Carlile the objective test was established by reference to zoning bylaws which mandate that a particular property be sold as a single parcel. In both cases, the properties in question fell completely within the required minimum zoning specifications. In Sendher, the frontal restriction prevented the severance of the lot into two saleable properties.

Based on the facts submitted, the subject property was zoned one acre residential at the time of sale and and the bylaw required a minimum frontage of 164 feet. The residence fronted XXXXXXXXXX which had a frontage of XXXXXXXXXX feet and the property had a frontage of approximately XXXXXXXXXX feet on XXXXXXXXXX .

Since the subject property is XXXXXXXXXX acres and well in excess of the minimum zoning requirement and there was an assemblage of properties, the facts of this particular case are clearly distinguishable from the factual situations addressed in Yates, Carlile and Sendher.

In our view, the requirements under the zoning bylaw do not establish that the entire parcel of land was necessary for use and enjoyment as a residence.

Possibility of Subdivision

Although the properties in Sender, Brohman and Michael exceeded the minimum acreage requirements under zoning bylaws, the taxpayers were still successful in establishing that the entire property was necessary for the use and enjoyment as a residence.

In this case the property exceeds the minimum zoning requirement of one acre and the taxpayer submits that it was unlikely that the property could be subdivided XXXXXXXXXX Developing the property in accordance with its planned uses would require an assemblage of adjacent properties. To support his position, the taxpayer states that the First Report was commissioned to get expert advice on the possibility of subdivision. In summary, the report concludes that "XXXXXXXXXX " and "XXXXXXXXXX "

The facts indicate that there was an assemblage of properties yet the First Report does not consider this important fact. In our view the assemblage of properties specifically address many of the arguments raised by the taxpayer with respect to subdivision.

The First Report asserts that a XXXXXXXXXX has a significant impact on the potential subdivision of the property. The independent appraisal ascertains that only XXXXXXXXXX acres of the taxpayer's property is useable area after giving consideration to XXXXXXXXXX . In this regard, the independent appraisal provides a measurement of XXXXXXXXXX XXXXXXXXXX which indicates that the impact of XXXXXXXXXX is not substantial in size or proximity to the housing unit.

The First Report asserts that the lack of sewer services was a factor limiting subdivision of the property but both the First Report and independent appraisal acknowledge that the XXXXXXXXXX registered a statutory right of way in XXXXXXXXXX 2005.

Both the First Report and the independent appraisal comment on the "highest and best use" utilizing the definition in The Canadian Uniform Standards of Professional Appraisal Practice. In circumstances where a government body such as a school board acquires land, the highest and best use is significant because the land is not generally developed to its maximum market potential. In addressing the issue of highest and best use, Russel M.J. in Lulu Island Holding Ltd. v. Greater Vancouver Sewerage and Drainage District (2007 BCSC 938) acknowledges that definition in p. 40 as set out in Holdom v. British Columbia Transit (E.C.B. No. 18/01/255). Based on the case law, the appropriate test is a probability of subdivision which is greater than 50% after considering the interaction of four criteria: legal permissibility, physical possibility, financial feasibility, and maximum profitability. In our view, after reviewing the documentation in light of those criteria, the taxpayer has not established that the probability of subdivision is less than the 50% threshold.

Conclusion

In conclusion, after considering the one acre requirement under the zoning bylaw, it is our view that the taxpayer has not established that the portion of land in excess of 1/2 hectare is necessary to the use and enjoyment of the housing unit as a residence.

For your information, unless exempted, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should the taxpayer request a copy of this memorandum, they may request a severed copy using the Privacy Act criteria, which does not remove taxpayer identity. Requests for this latter version should be made by you to Mrs. Celine Charbonneau at (613) 957-2137. In such cases, a copy will be sent to you for delivery to the taxpayer.

We trust the above comments are of assistance.

Yours truly,

Sharmini Ratnasingham
Manager
for Director
Ontario Corporate Tax Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch