Dean Blachford, Tax Litigation Lawyer
Brittany Rossler, Law Student

The Canada Revenue Agency (“CRA”) recovered $291.7 million as a result of audit activities related to real estate in Ontario from April 2015 to June 2017.[1] Individuals must now report the sale (or deemed sale) of their principal residence on their annual tax return.[2] With the CRA’s increased attention to the real estate sector, it is more important than ever for real estate professionals to be able to alert their clients to the taxes associated with buying and selling property.

In this article, we explain property flipping, clear up the common misconceptions regarding the principal residence exemption, and outline the legal test for identifying when a flip has occurred. We also highlight why real estate lawyers, brokers, and agents are particularly at risk of a property flipping reassessment.

WHAT IS PROPERTY FLIPPING?

The CRA has identified property flipping as one of its key areas of concern in the real estate sector. Popular television programming and the conditions of the Canadian real estate market have made property flipping an increasingly common practice. Property flipping occurs when someone purchases real estate with the intention of quickly reselling it for profit.

If the CRA determines that you have engaged in property flipping, it will tax you on your profit from the sale. Despite certain common misconceptions, your profits will not be sheltered by the principal residence exemption even if you lived in the property for a certain period of time. In addition, while the sale of a property usually constitutes a capital gain, only 50% of which is taxed, CRA will tax 100% of any gains from property flipping.[3] (More on these misconceptions below.

Here are some examples of property flipping:

  • Purchasing a property, fixing it up, and reselling it for a profit.
  • Purchasing a property in a developing area, waiting for it to appreciate, and then selling it for a profit.
  • Purchasing a pre-construction property and reselling it for a profit when the project is complete.
  • Purchasing pre-built condos from a developer and then selling them at a profit before taking possession of the property (a kind of “shadow flipping”).

LEGAL TEST: AM I ENGAGED IN PROPERTY FLIPPING?

Happy Valley Farms Ltd v MNR [4] sets out six key factors for distinguishing between property flipping and non-property flipping for taxation purposes:

  • The nature of the property sold: property that the individual does not rent out for business income or live in is more likely to have been purchased with an intention to flip.
  • The length of time the property was owned: generally speaking, flipped property is only owned for a short period of time before it is sold.
  • The frequency or number of other similar transactions: if the individual frequently buys and sells property in a short period of time, they are likely engaged in property flipping. It is important to note, however, that isolated or infrequent sales can still be property flipping.
  • The amount of work or effort expended on the property: an individual may be involved in flipping if they put work into bringing the property into a more marketable condition and/or made special efforts to find or attract purchasers.
  • The reason why the property was sold: sudden emergencies or other circumstances may provide an explanation that precludes a finding of property flipping.
  • The individual’s intentions at the time the property was acquired: did the individual intend to sell the property for profit when they bought it? Further, did their conduct match their stated intention? Property flipping cases often turn on these questions. Essentially, the CRA–and if need be a judge of the Tax Court of Canada–will put themselves in the position of the individual at the time of purchase to determine what that individual intended to do with the property.

THE IMPACT ON REAL ESTATE PROFESSIONALS

The CRA is particularly interested in real estate professionals who are involved in the purchase and sale of property because they are presumed to have inside knowledge (special knowledge, training, expertise, etc.) that they are using to make a profit. The “frequency or number of other similar transactions” factor under the Happy Valley test will point towards a flip where the individual is familiar or closely associated with the real estate business, regardless of the number of properties they have flipped themselves.

ADDITIONAL TAX CONSEQUENCES OF PROPERTY FLIPPING

On top of taxing 100% of the profits, the CRA may also impose significant penalties if it concludes that you were engaged in property flipping. Moreover, if the profits are derived from the sale of a new property or condo, the CRA will deny the New Housing Rebate and come back for the HST on the purchase price. Finally, if you invested in upgrading the property but no longer have receipts for your investments, the CRA will not allow you to deduct those expenses from the profit.

Often, the CRA only decides that someone has been involved in property flipping after they have had multiple sales. As a result, reassessments for property flipping can easily total more than $1 million of unreported income.

BUT I THOUGHT…

A number of myths exist around property flipping. For example, many individuals wrongly believe that living in a property for one year will automatically qualify them for the principal residence exemption from capital gains. Many people also believe that the profit from the sale will only be taxed as a capital gain even if the principal residence exemption is denied.

As explained in Happy Valley, there are no bright line rules for determining whether property sales are capital gains or business income. If the CRA thinks you are speculating it will go after the amounts as business income regardless of how long you lived in the house. Because the burden of proof in tax cases is on the taxpayer, it is up to you to disprove the CRA’s reassessment by proving that you did not intend to sell the property for profit when you acquired it.

HOW CAN WE HELP

At HazloLaw – Business Lawyers we have extensive experience successfully representing individuals against property flipping and other real estate related reassessments. Please contact us if you or one of your clients is facing a tax dispute with the CRA or would like advice on how to avoid one.

Also, we frequently present to large groups of real estate professionals on house flipping and similar tax issues. Please contact us if you would like us to present to your team.

Footnotes

[1] Canada Revenue Agency, “How does the Canada Revenue Agency address non-compliance in the real estate sector?” (Ottawa: CRA, 3 Nov 2017), online: <https://www.canada.ca/en/revenue-agency/programs/about-canada-revenue-agency-cra/compliance/does-canada-revenue-agency-address-non-compliance-real-estate-sector.html>.

[2] Canada Revenue Agency, “Reporting the sale of your principle residence for individuals (other than trusts)”, (Ottawa: CRA, 28 Feb 2017), online: <https://www.canada.ca/en/revenue-agency/programs/about-canada-revenue-agency-cra/federal-government-budgets/budget-2016-growing-middle-class/reporting-sale-your-principal-residence-individuals.html>.

[3] The only time CRA will tax you on 50% of the gain is if you purchased the property for the purpose of using it to generate income (such as by renting it out) and then went on to sell it for a profit.

[4] Happy Valley Farms Ltd v MNR (1986), 86 DTC 6421 (FCTD).

This article is for informational purposes only and does not constitute legal advice. If you wish to discuss your issue with a lawyer, contact Dean Blachford today.  613-747-2459 ext.310, dblachford@hazlolaw.com