In recent years, the Canada Revenue Agency (the "CRA") has become more critical of real estate transactions claiming tax non-compliance has contributed to increasing housing prices. One category of transactions the CRA is examining more closely is condo flipping. CRA has had a condo flipping audit project for several years. CRA routinely contact condo developers for a list of purchasers and follows up with all of those purchasers to see if they sold the condo or are living in it. Condo flippers buy pre-build or pre-construction condo units and attempt to sell them for a profit either shortly after purchasing the unit or once construction is complete. Condo flippers may also carry out assignment sales where they assign their contract for the condo unit to a buyer before taking possession of the condo. The CRA has found condo flippers incorrectly categorizing their taxable income to qualify for lower tax rates by claiming capital gains treatment instead of income treatment.
TAX IMPLICATIONS OF CONDO FLIPPING
The primary issue for condo flippers is correctly categorizing the income earned from the sale of the condo units as business or capital gains income. Though claiming business income will allow the condo flipper to deduct certain expenses incurred in selling the unit, most condo flippers would prefer to claim capital gains income on the sale. This preference results from taxpayers paying less tax on capital gains. Only 50% of the profit of the condo unit sale is taxable for capital gains, whereas the entire income from the sale is taxable if the income is classified as business income.
The Income Tax Act does not have a bright-line rule for determining whether income is from business or capital gains. Instead, the courts have identified a number of factors which may be considered. These factors include:
- The profession of the taxpayer
- How long did the taxpayer own the property
- The frequency and number of real estate sales the taxpayer has conducted
- Money borrowed for the purchase of the property
The factors are directed towards determining the intention of taxpayer, which is the central consideration in the classification of disposition transactions. Effectively taxpayers engaging in condo flipping as a business should be claiming business income on the sale of their units. Assignments sales will virtually always be considered business income.
Similar factors to those used in classifying business or capital gains income apply in determining whether the principal residence exemption has been legitimately claimed. The principal residence exemption renders the sale of a taxpayer's principal residence tax-free for the years it was his or her principal residence. The exemption can be claimed only where the taxpayer intends to and does ordinarily reside in the property. Conversely, a condo flipper may move into the condo unit briefly before selling the unit just to claim the principal residence exemption on the sale. These claims of the principal residence exemption will be denied by the CRA as the flipper did not intend to ordinarily reside in the unit as his or her principal residence.
Condo flippers must also be conscious of the impacts of GST/HST taxation on the purchase and sale of the condo units. As the purchaser of the condo unit, the flipper would like to claim the New Housing Rebate under section 254 of the Excise Tax Act. This rebate allows the purchaser of a new or substantially renovated home to recover a portion of the GST/HST paid on the purchase. However, the second requirement for claiming this rebate is the use of the home as the owner's primary place of residence. Most condo flippers fail to fulfill this requirement, and thus cannot claim the rebate.
Condo flippers additionally generally have GST/HST remittance requirements on the sale of condo units. GST/HST must generally be paid on the sale of a new build or substantially renovated home. Condo flippers who are buying unbuilt or partially built units then selling the units once complete will likely be caught by this rule and should be remitting GST/HST.
FALSE FLAGS: BYGRAVE V. THE QUEEN
The CRA's efforts to catch condo flippers underpaying their taxes has wrongly ensnared taxpayers correctly reporting their taxes such as in the recent case of Bygrave v. The Queen. In 2006, Mr. Bygrave, a TTC operator, purchased a condo unit in the pre-construction stage, which he intended to move into once construction was complete. His plans changed when his father passed away and his mother came to live with him. The condo was not suitable for him and his mother, so he sold it without having lived in it. Mr. Bygrave reported his earnings from the condo sale as a capital gain. The CRA reassessed him, claiming the sale was "an adventure in the nature of trade" and Mr. Bygrave had earned business income from the sale.
The court applied a four-factor test to determine whether Mr. Bygrave had acted "in the nature of trade" and thus earned business income on the sale. The first two factors of the test, intention of the taxpayer and the nature of the taxpayer's profession, both favoured Mr. Bygrave having not acted "in the nature of trade". The nature and use of the property factor suggested Mr. Bygrave had earned business income. The final factor of whether borrowed funds were used and the length of ownership of the property was neutral. The court found Mr. Bygrave had been correct in claiming capital gains income instead of business income on the sale of the condo unit.
TAX TIPS: UNDERSTANDING YOUR CONDO TRANSACTION CAN PREVENT CRA SCRUTINY
While Mr. Bygrave's received a favourable outcome consistent with his filing position, he spent about five years fighting the CRA for this result. Mr. Bygrave's case demonstrates how the division between capital gains and business income is a grey area which can confuse the CRA and taxpayers alike. Our experienced Canadian tax lawyers deal with this situation every week and can help you avoid ending up in a similar position. Proactively understanding your correct filing position can help avoid CRA tax audit or reassessment. Still, there are opportunities to correct errors by either the taxpayer or CRA in assessing the type of income earned in the sale of a condo unit. Condo flippers can use the Voluntary Disclosure Program to correct their capital gains/business income filing position and to report unremitted GST/HST. Taxpayers can also object to incorrect CRA tax assessments. To better understand your tax obligations when selling your condo or to contest a CRA tax assessment, contact our top Canadian tax lawyers.
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.