The Residential Property Flipping deeming rule announced in the 2022 Federal Budget will not apply if the disposition of residential property is on account of a "life event". Accordingly, it appears that Canada Revenue Agency (CRA) has decided to officially recognize that taxpayers do not always buy and sell homes in relatively short periods solely to make a profit. In fact, many do so because of life circumstances.
For instance, a taxpayer might sell her condominium in order to purchase a home with her fiancé. When the relationship fails before the wedding, the house is sold and she then buys another condominium. A CRA auditor may recognize the buy and sell pattern and claim that the taxpayer was in the property flipping business. In practice, this is common and considering the average CRA auditors' willingness to increase taxable income at any opportunity, reasonable explanations are not always fairly considered at the audit stage.
Under normal circumstances, if an owner-occupied residence is sold, any increase in price will be reported and taxed as a capital gain or the principal residence exemption is claimed. If it is the former, only 50% of the gain is subject to tax. If the property you sell is your principal residence, then you do not pay tax. In contrast, if a gain is taxed as business income, 100% is subject to tax. CRA auditors target this discrepancy in an attempt to assess profit as business income and increase tax recovered.
When disputing such assessments, it is up to the taxpayer to prove that they were not involved in the business of flipping properties for profit. In unfortunate cases, CRA will claim that the income from the sale(s) should have been reported as business income and then go further and if, for example, renovations were done to the property, characterize the taxpayer as a builder who should have collected and remitted GST/HST on the sale. A taxpayer may be considered to be a "builder" if the CRA considers the residential property sale to have occurred on account of a business and the taxpayer built or substantially renovated the property (or paid someone to do same). Considering the inflated value of Canadian homes, it is not unusual for the tax outcome to differ by the hundreds of thousands.
The new deeming rule proposed in the 2022 Federal Budget makes it easier for CRA to characterize a gain from a residential property sale as business income. It is intended to apply to residential property dispositions on or after January 1, 2023. If a property is owned for less than 12 months before sale, it is deemed to have been bought and sold for profit from a business. Therefore, the taxpayer cannot take advantage of the preferred capital gains tax rate or the principal residence exemption.
As mentioned, there are "life event" exceptions to the deeming rule that will apply if proven to the satisfaction of CRA or the Tax Court. For instance, if the disposition occurred on account of death or in anticipation of, the principal residence or capital gains characterization persists. Also, CRA recognizes that a taxpayer might purchase a larger property due to an addition to household (e.g., a child). Or if a property is sold due to breakdown of a marriage or common law partnership. The CRA will also not apply the deeming rule if the disposition occurred to due personal safety concerns (e.g., domestic violence), disability or illness, a change in employment, insolvency, and involuntary disposition (e.g., destruction due to a natural disaster).
Nevertheless, even if a taxpayer experiences a life event as contemplated, and the property was sold after 12 months, the burden remains to provide facts and arguments to CRA establishing that the proceeds of disposition are not income from a business.
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.