Heavy action in residential real estate in Vancouver and Toronto has attracted large numbers of speculators, many of whom are non-residents, who are buying and selling houses and condominiums with no intention of making any of these properties their principal residence. However, these speculators frequently claim the principal residence exemption on their tax return, thus avoiding a tax hit when selling at healthy profits.
Between the pressure this has placed on genuine homebuyers and lost tax revenue, governments are beginning to take notice. In early October, the federal government announced that it will impose new residency requirements on home buyers who wish to claim the principal residence exemption when they sell: they will be required to be Canadian residents when the purchase is made. That follows a move by British Columbia last summer to cool sales in Vancouver by imposing a 15% tax on homes being purchased by non-residents.
So, while most of your clients are unlikely to be speculators, it's wise to stay abreast of how the Canada Revenue Agency (CRA) is reacting to the evolving situation. For one, the agency has begun audits of high-value transactions in both cities.
Jamie Golombek, managing director of tax and estate planning, CIBC wealth strategies, with Canadian Imperial Bank of Commerce in Toronto, says the CRA is "looking for flipping by people who don't live in the houses, or don't live in them long, and claim that it was their principal residence."
The CRA website identifies several situations where it's concerned that the appropriate taxes are not being paid, including the use of questionable sources of funds, property flipping, and unreported goods and services or harmonized sales taxes on new or substantially renovated properties.
Making sure your clients have an understanding of the tax consequences of real estate transactions is important. Golombek notes that this also underlines the importance of "know your client" rules. "You want to make sure you haven't taken on a non-resident client who's posing as a resident."
Adds Aurèle Courcelles, assistant vice president, tax and estate planning, at Investors Group Inc. in Winnipeg: "If there are any questions about the tax situation for any of your clients, a good idea [would be] to suggest your client talk to a tax accountant or lawyer."
Here are some key points your clients need to know:
- QUESTIONABLE SOURCE OF FUNDS. Purchase of an expensive house - for $2 million, for example - by a taxpayer with reported modest income is a red flag for the CRA. The agency will want to know how that person could afford to purchase the house, and how he or she can afford to live there.
There may be a perfectly good reason, such as an inheritance or lottery winnings. But that reason may need to be proved.
- INCOME FROM REAL ESTATE TRANSACTIONS. Canada provides a capital gains exemption for the sale of a taxpayer's primary residence. Most Canadians sell their home and buy another only occasionally and thus easily qualify for the exemption.
However, if there are frequent sales of primary residences, the CRA may question whether the taxpayer is primarily "investing" in real estate - in which case the gain on the sale of a property doesn't qualify for the exemption, so 50% of the gain should be included in income.
Depending on the frequency of sales and also how much renovation is done to a property, the CRA may consider the activity to be a "business" rather than "investing" - in which case the full gain on the sale should be counted as business income.
The CRA doesn't provide any guidelines regarding how it decides that selling a residence is investment or business income.
- Shadow Flipping. This term refers to multiple sales between the agreement for sale of a property and its closing. Courcelles gives a fictional example:
A house is sold by Owner X for $1.2 million to Buyer A. But unbeknownst to X, A sells the house before closing to Buyer B for $1.5 million - thereby making $300,000. Buyer B then sells it to Buyer C for $1.8 million, with Buyer B also making $300,000.This sequence is legal, but the gains from each of the intermediate sales must be declared as investment or business income.
- Residency status. To claim the principal residence exemption from capital gains taxes, you must be a resident of Canada. Generally, that means living in Canada. However, people who live outside Canada for extended periods may qualify, including people working elsewhere for years. Residency is determined on a case-by-case basis, taking residential ties in Canada, the purpose and duration of visits outside Canada, and social and economic ties outside of Canada into account. Residents of Canada are required to report their worldwide income; non-residents must declare only their Canadian-source income.
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