With the real estate market continuing to soar in some parts of Canada, the government remains concerned with taxpayers who purchase residential real estate with the intention of “flipping” it — selling it in a short period of time to realize a profit. Under Canadian tax law, when properties are flipped in this manner, the profit is fully taxable as business income. In other words, taxpayers aren’t eligible for the 50% capital gains inclusion rate nor the principal residence exemption (PRE).
In recent years, the Canada Revenue Agency (CRA) has been cracking down on perceived abuse of the exemption, most recently with a letter campaign. The agency sent letters to those “who may have applied the principal residence exemption in error.” Beginning in January 2022, educational letters were sent to approximately 1,700 taxpayers who claimed the PRE in two specific scenarios.
One of the letters was sent to taxpayers who claimed the PRE in both their 2018 and 2019 tax returns. The letter identifies the properties on which the taxpayers claimed the PRE and explains that when you sell your home, you do not usually have to pay tax on any profit from the sale because of the PRE; however, if you buy a property with the main intention of selling it, you will owe tax on any resulting gain (or profit). The CRA further points out that, in these situations, the gain on the sale may be considered business income, in which case it’s 100% taxable, or could be considered a capital gain, in which case only half the amount needs to be included in income.
A second educational letter was directed at taxpayers who claimed the PRE and had previously reported gross rental income on their returns.
Both letters politely ask the taxpayer or their representative to “review” their return “to ensure that you accurately reported your real property dispositions and that you were eligible to claim the principal residence exemption for both properties.” The CRA encourages taxpayers who need to make any corrections to change their returns, and indicated it will follow up by phone in the coming weeks.
In this month’s federal budget, the government proposed to introduce a new deeming rule to ensure that profits from flipping residential real estate are always subject to full taxation. Specifically, profits arising from the disposition of residential real estate, including a rental property, that was owned for less than 12 months would be deemed to be business income. The PRE will not be available.
The new deeming rule won’t apply, however, if the sale or disposition is related to a life event, including: death, the addition of a person to a household, separation, personal safety, disability or illness, employment change, insolvency or an involuntary disposition such as an expropriation.
The new measure will apply to any sales of residential properties starting on Jan. 1, 2023.
Jamie Golombek, CPA, CA, CFP, CLU, TEP, is the Managing Director, Tax & Estate Planning with CIBC Private Wealth in Toronto.