New anti-flipping rules for residential real estate (including rental properties) that came into effect in 2023 were designed to “reduce speculative demand in the marketplace and help to cool excessive price growth.”
The rules essentially prevent you from claiming the principal residence exemption (PRE) to shelter the capital gain realized on the sale of your home if you’ve owned it for less than 12 months. If you’re caught by the rule, the gain on the sale is 100 per cent taxable as business income rather than only 50 per cent taxable as a capital gain, subject to certain exemptions for life events such as death, disability, separation and work relocation.
Although these new rules only came into play as of 2023, the Canada Revenue Agency can still challenge real estate “flips” that took place prior to 2023 if it feels a taxpayer has speculated and flipped a property for a quick profit. That’s exactly what happened in a new case decided last week involving a Vancouver taxpayer whose 2018 tax return was reassessed for failing to report the gain on her sale of a condominium unit, relying on the PRE.
In February 2015, the taxpayer entered into a pre-construction contract for the purchase of a condo located in North Vancouver for $660,000. Construction was completed, and she took possession in October 2017.
The property was then listed for sale by the taxpayer on Dec. 6, 2017. It didn’t sell right away and was subsequently relisted with a different agent on Feb. 21, 2018. A month later, on March 22, 2018, the taxpayer sold the property for $1,161,000, which closed on June 28, 2018. After deducting her costs, the gain or profit on sale was approximately $457,000.
The taxpayer claimed this property as her principal residence, and thus did not report the gain on her 2018 tax return. The CRA disagreed and reassessed the taxpayer on the basis that she was engaged in a business or “an adventure or concern in the nature of trade,” and included the $457,000 in the taxpayer’s income as business income.
Under the Income Tax Act , the PRE can only be used to shelter a gain from tax if the property sold is considered to be capital property. If the property isn’t capital property because it’s sold by an individual in the course of a business, then the PRE cannot shelter the gain from tax.
Thus, the question before the Tax Court was whether the taxpayer was carrying on a business in respect of her purchase and sale of the property. If so, the taxpayer’s profit is said to be on “income account,” meaning that any profit from sale would be treated as 100 per cent taxable business income.
Prior jurisprudence has developed a series of tests that help the courts determine whether an individual bought an asset on income or capital account. The tests consider: the nature of the property sold, the length of period of ownership, the frequency or number of other similar transactions, the work expended on or in connection with the property, the circumstances that were responsible for the sale of the property and the taxpayer’s motive.
The judge reviewed each factor, making various observations. First, the period of ownership from closing (Oct. 2017) to sale (June 2018) was fairly short, pointing toward an adventure or concern in the nature of trade.
Second, it appears that the taxpayer, along with her former spouse, was previously engaged in a number of real estate transactions over the years, several of which the judge called “notable.” For example, in October 2005, the former couple jointly acquired a property in West Vancouver for $4.2 million and spent additional amounts on upgrades. The property was sold in July 2010 for a loss, which was reported as a business loss for tax purposes.
In June 2008, the taxpayer purchased a condominium unit in West Vancouver with a friend on a 50-50 basis for approximately $698,000. The property was listed for sale a few weeks later, and was sold in June 2009 for net proceeds of $588,616, resulting in a loss.
The taxpayer attempted to adjust her 2009 income tax return to treat her share of the loss as a business loss, which prompted inquiries from the CRA. In a letter to the CRA, the taxpayer explained that she intended to “pursue small-scale property refurbishment projects to generate a source of income, and that the (property sold) was to be the first such project.” She also stated that she had “plenty of experience owning and refurbishing properties” and that, after relocating to Vancouver, real estate “seemed like a logical sector to be making investments.”
In court, the taxpayer testified that she moved a few items into her North Vancouver condo around Nov. 3, 2017, and in late November moved in some additional furniture, including two couches, a chest of drawers, bedside tables, a bed for the main bedroom and a sofa bed in the second bedroom. She said her daughters shared that room.
Her evidence was that she lived at the condo from Nov. 23, 2017, to June 2018.
The judge didn’t buy this argument. The taxpayer’s other property remained available, and that is likely where the taxpayer and her daughters had been residing when the daughters were not with her ex. As the judge said, “It is highly improbable that (her teenage daughters), would have moved into a smaller condominium and shared a bedroom after having separate bedrooms at (their previous three properties).”
The judge also noted that the taxpayer didn’t bother to install Wi-Fi at the condo, nor did she change the address on her driver’s license, nor update her address with the CRA. Furthermore, when the condo was listed for sale, it was listed as “brand new” in the real estate listing.
As the judge noted, “occupancy involves more than simply moving a few items into the premises. … It seems illogical that she would list the (condo) on December 6, 2017, and — while at the same time — move in and begin occupying the property primarily as a place of residence.”
As the judge wrote, “On a balance of probabilities, and considering the totality of the evidence adduced together with common sense, I am unable to find that the (taxpayer) occupied the (condo) as a place of residence. … Instead, it is more probable that the (taxpayer) and her daughters continued to reside primarily at the four-bedroom home.”
This led the judge to conclude that the taxpayer had acquired her interest in the condo with a speculative intent, motivated primarily by the possibility of resale at a profit. Thus, the judge ruled that the profit was properly taxable as business income.
Jamie Golombek, FCPA, FCA, CFP, CLU, TEP, is the managing director, Tax & Estate Planning with CIBC Private Wealth in Toronto. [email protected] .
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https://financialpost.com/personal-finance/taxes/cra-challenge-principal-residence-expemption-quick-home-flips
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