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26 April 2024

Canadian Tax Lawyer Explains CRA's Policy Positions For Canada's New Property Flipping Rules

RS
Rotfleisch & Samulovitch P.C.

Contributor

Rotfleisch Samulovitch PC is one of Canada's premier boutique tax law firms. Its website, taxpage.com, has a large database of original Canadian tax articles. Founding tax lawyer David J Rotfleisch, JD, CA, CPA, frequently appears in print, radio and television. Their tax lawyers deal with CRA auditors and collectors on a daily basis and carry out tax planning as well.
In January 2024, the Canada Revenue Agency's Income Tax Rulings Directorate published its first two technical interpretations on the newly minted "house flipping" rules under section 12 of the Canadian Income Tax Act.
Canada Tax
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Introduction – The CRA's Publishes its First Opinions on New House Flipping Rules

In January 2024, the Canada Revenue Agency's ("CRA") Income Tax Rulings Directorate published its first two technical interpretations on the newly minted "house flipping" rules under section 12 of the Canadian Income Tax Act. Those technical interpretations presented two different scenarios to evaluate how the exemption rules under the new house flipping regime would be applied to Canadian taxpayers.

The CRA's Income Tax Rulings Directorate is the CRA's administrative arm responsible for preparing income tax technical interpretations, providing Canadian taxpayers with the CRA's interpretation of specific provisions within the Canadian Income Tax Act. While those technical interpretations are simply policy positions and do not have force of law, they provide valuable insight for taxpayers and practitioners to anticipate how specific tax provisions will be applied.

Those interpretations concern two distinct and important exemptions to the house flipping rules that are expected to be relevant for a wide range of taxpayers: (i) sales in anticipation of death; and (ii) the insolvency life-event exception. This article will proceed in three parts. First, this article will review the new house flipping rules found under section 12 of the Income Tax Act, and the various exceptions created for the applicability of those rules including the two above-mentioned exceptions. The CRA's technical interpretations will then be summarized as they apply to these two exceptions. This article will then conclude with some pro tax tips for Canadian taxpayers on the anticipated benefit of these technical interpretations, and how technical interpretations can prove to be a valuable tool in defending against tax penalties.

Subsection 12(12)-(14): The House Flipping Rules

The house flipping rules now found under subsections 12(12)-(14) of the Income Tax Act were first announced in the 2022 Federal Budget, and received royal assent on December 15, 2022, and took effect starting with the 2023 taxation year.

Very simply, under the house flipping rules, if a taxpayer would realize a gain on the disposition of a "flipped property", then that taxpayer is deemed to have carried on a business with respect to the property. As a result, the proceeds of disposition will be treated as fully taxable business income. Further, the property will be deemed to be inventory, and not a capital property, so the principal residence exemption will be unavailable to shelter any resulting gain from taxation. A "flipped property" incudes any housing unit or right to acquire a housing unit located in Canada owned (or in the case of a right to acquire, held) for less than 365 days prior to its disposition.

Paragraph 12(13)(b) provides a number of exceptions to this deeming rule. If an exception is satisfied, the gain on disposition might be characterizable as a capital gain rather than business income. (The existing rules based on tax law cases for determining whether proceeds of disposition are business income or a capital gain can still separately apply, and should not be ignored.) And in those circumstances, the principal residence exemption might also be available, assuming those conditions are satisfied as well.

The exceptions include cases where the disposition of the housing unit can reasonably be considered to occur due to, or in anticipation of:

  • the death of the taxpayer (or a person "related" to the taxpayer);
  • the taxpayer or a related person is suffering from a serious disability or illness;
  • a related person joining the taxpayer's household or the taxpayer joining a related person's household (e.g., birth of a child, adoption, care of an elderly parent);
  • the breakdown of a marriage or common-law partnership of the taxpayer, where the taxpayer has been living separate and apart from a spouse or common-law partner for at least 90 days prior to the disposition;
  • a threat to the personal safety of the taxpayer or a related person (e.g., the threat of domestic violence);
  • an involuntary termination of the employment of the taxpayer or the taxpayer's spouse or common-law partner;
  • an eligible relocation of the taxpayer or the taxpayer's spouse or common-law partner (e.g., generally, a relocation that enables the taxpayer to carry on business, be employed or attend full-time post-secondary education);
  • the insolvency of the taxpayer; or
  • the destruction or expropriation of the property.

Additionally, subsection 12(14) of the Income Tax Act denies any losses from the disposition of a flipped property. In other words, if a property is sold for a loss within 365 days of acquiring ownership, and an exception does not apply, then any resulting loss cannot be claimed by the owner for tax purposes.

The CRA's Technical Interpretations Concerning the House Flipping Rules

As mentioned above, in January 2024 the CRA published two technical interpretations concerning its view on two of the available exceptions to the house flipping rules: (i) sales in anticipation of death; and (ii) the insolvency life-event exception. These technical interpretations will be explored in turn.

External T.I. 2023-0990101E5 – Estate Administration

In the first of the two CRA technical interpretations, the CRA was presented with a straight-forward fact pattern in an estate administration context. In the example provided, an individual passes away in 2021, and that individual's estate acquires ownership of a housing unit. Due to estate administration issues, title to the housing unit is not transferred to the individual's child beneficiary until 2023. Following that transfer, the child disposes of the property within 365 days of acquiring title.

First, the CRA acknowledged that for purposes of the flipped property rules, the beneficiary would not be considered to have owned the property since it was acquired by the estate. (For policy reasons, the deeming provision that would apply for the purpose of the principal residence exemption under paragraph 40(2)(b) of the Income Tax Act was not extended to apply to these new housing rules. Thus, for purposes of the house flipping rules, ownership of a housing unit will be treated as having begun once title to the property is actually transferred to the beneficiary.)

The CRA narrowed the focus of its analysis to the particular exemption under subparagraph 12(13)(b)(i), wherein a property will not be viewed as a "flipped property" where a disposition of a housing unit "...can reasonably be considered to occur due to, or in anticipation of... the death of the taxpayer or a person related to the taxpayer." The CRA observed that, if it can be substantiated there was a sufficiently clear connection between the death of the individual and the child beneficiary's eventual disposition of the housing unit such that the disposition would reasonably be considered to have occurred due to the deceased's passing, then the result gain would not be deemed as business income.

The CRA refrained from elaborating any further. Nor did the CRA provide any examples of facts or evidence which could support a reasonable connection between the individual's passing and the property sale that could give rise to this exception. As a result, this interpretation is largely a restatement of the law, and is unfortunately of limited practical use.

External T.I. 2023-0991461E5 – Insolvency

In the second of the CRA's technical interpretations, the CRA was presented with another straight-forward fact pattern in an insolvency context. In that example, a homeowner is driven to sell a housing unit in an effort to pay for personal expenses. The costs associated with maintaining the housing unit resulted in cash flow issues, racking up credit card debt to cover basic needs, and the sale was made to improve the taxpayer's financial situation.

The CRA first acknowledged that subparagraph 12(13)(b)(viii) provides an exemption from the house flipping rules where the disposition of the housing unit in question can reasonably be considered to occur due to, or in anticipation of, the insolvency of the taxpayer. The CRA agreed with the underlying proposition that a taxpayer who faces mounting debt to pay for basic personal expenses, and where those conditions are expected to continue or have been ongoing, and disposing of the housing unit to improve their financial situation, could qualify for the insolvency life-event exception. The CRA cautioned however it would still remain a question of fact whether the profits from the disposition would be treated as business income or a capital gain. In other words, if the property were acquired for a re-sale and profit, then even if the sale was prompted by financial difficulty or insolvency, the exemption would not be available.

Unlike the first technical interpretation, this opinion provides some useful guidance about the factors CRA will consider when reviewing this exception. The CRA's position acknowledges that it will evaluate the length of time a taxpayer has faced mounting personal debt when rationalizing whether a taxpayer's property sale was reasonably "in anticipation of" insolvency. Implicitly, when determining if a taxpayer qualifies, the CRA will place a greater value on evidence of a taxpayer's attempts to escape a debt spiral prior to any decision to sell a housing unit. As well, this suggests the financial planning skills of the taxpayer should have little bearing on whether or not the exception is available. In other words, a taxpayer who acquires a property for personal use while over-leveraged, or who under-estimated the costs involved in maintaining a property, should not be prevented from qualifying for this exception.

Pro Tax Tip: CRA's Technical Interpretations Can Prove to be a Useful Shield for Tax Penalties

The new house flipping rules under the Income Tax Act were developed specifically to tackle misuse of a capital gains determination and of the principal residence exemption by property flippers in Canada. The CRA has also aggressively ramped up its efforts to audit taxpayers claiming the principal residence exemption for this reason. Any taxpayer who claims an exception to the new property flipping rules will likely have a tax audit from the CRA on a similar basis.

However, reasonably relying on the CRA's published views can help act as a shield against the CRA's powers to audit and reassess a taxation year. For example, the CRA is entitled to reassess a statute-barred tax year if it believes the taxpayer or his or her representative "made any misrepresentation that is attributable to neglect, carelessness or wilful default" when filing a tax return for that year. However, if a taxpayer can show that return was prepared and filed in accordance with the CRA's own published views, that will support that the taxpayer was in fact duly diligent when filing. The CRA would, in effect, have to argue the taxpayer was negligent by filing taxes in accordance with the CRA's own published views of how that income should be reported. The courts have also, and quite fortunately, recognized the same.

So, it is crucial that any taxpayer planning to purchase and sell a property and claiming an exception to the house flipping rules obtain tax planning advice from an expert Canadian tax planning lawyer and then document and record as much as possible about the circumstances that gave rise to the sale, as well as any CRA opinions or publications relied on when claiming that exception. And in any uncertain tax situation, you should always consult with our tax lawyers to advise on your correct filing position, including your entitlement to any exception under these new house flipping rules, and what documents and records you should maintain when claiming any exception.

FAQs:

What Are the New House Flipping Rules under the Canadian Income Tax Act?

Very simply, under the house flipping rules, if a taxpayer would realize a gain on the disposition of a "flipped property", then that taxpayer is deemed to have carried on a business with respect to the property. As a result, the proceeds of disposition will be treated as fully taxable business income. As a result, the principal residence exemption will be unavailable to claim for the property, even if it was ordinarily inhabited. A number of exceptions have been provided to this deeming rule, including where the sale of the property occurred because of (or in anticipation of), for example: (i) the death of the taxpayer or a related person; (ii) the breakdown of the taxpayer's marriage or common-law partnership; (iii) threats to the taxpayer's or a related person's personal safety; and (iv) insolvency of the taxpayer.

What are CRA Technical Interpretations?

The CRA's Income Tax Rulings Directorate is the CRA's administrative arm responsible for preparing income tax technical interpretations, providing Canadian taxpayers with the CRA's interpretation of specific provisions within the Canadian Income Tax Act. While those technical interpretations are simply policy positions and do not have force of law, they provide valuable insight for taxpayers and Canadian tax lawyers to anticipate how specific tax provisions will be applied.

What is a "Flipped Property"?

Under Canada's new house flipping rules, a "flipped property" is defined as any housing unit (or right to acquire a housing unit) located in Canada and owned (or in the case of a right to acquire, held) for less than 365 days prior to its disposition (including a sale). If a taxpayer realizes a gain on the disposition of a "flipped property", then that gain will be fully taxable business income and the principal residence exemption will be unavailable, unless an exception to the house flipping rules applies.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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