Even before the new tax law is set to be enacted in 2023, real estate deals are already being challenged by the agency.
The Canadian Revenue Agency (CRA) recently challenged a perceived real estate “flip” in court and got mixed results–a preview of what the new federal anti-flipping law will bring to the industry trade.
The tax legislation will prohibit using the principal residence exemption to shelter capital gains made on the sale of a property if you’ve owned it for less than 12 months, with specific exclusions such as death, incapacity, separation, and work relocation. Instead, the gain will be taxed at 100% as business income.
The new anti-flipping laws for residential real estate in Canada are set to take effect on January 1, 2023, and are intended to limit speculative demand in the market place and aid to moderate excessive price growth.
Even before the enactment of the law, the CRA had been challenging real estate transactions that cite principal residence exemption–most recently, with a case in Toronto where the homeowner went to Tax Court to contest the CRA’s denial of her principal residence claim.
The taxpayer stated in court that she had “tumultuous relations” with her now ex-husband from 2010 to 2014, resulting in an on-again, off-again relationship. But, she testified that she frequently visited the house in question during 2010 and 2011 “as a refuge from the acrimonious and abusive relationship with her now ex-husband,” and that because it was her principal residence, it should have been exempt from capital gains tax when she sold it in 2011.
The CRA disagreed, claiming that because the property was acquired and sold as “an adventure in the nature of trade” and therefore, its sale should be categorized as 100% taxable business income. It stated that because the taxpayer never changed her primary residence, employer T4 address, or other mailing addresses to this property, she “flipped” it for a big profit after totally reconstructing it in a relatively short amount of time.
The Tax Court revolved its decision around four questions:
- Should the transaction be correctly classed as an adventure in the nature of trade and hence taxable as business income or as capital property, granting capital gains treatment?
- If it was a capital property, and was it the taxpayer’s primary dwelling, allowing the gain to be tax-free?
- Was there enough misrepresentation on the taxpayer’s 2011 tax return (that is, the failure to declare the sale of the property) to allow the CRA to reopen the 2011 tax year, which would otherwise have been statute-barred and beyond the standard three-year reassessment period?
- Was the taxpayer’s filing of her 2011 tax return grossly negligent, and so subject to a gross negligence penalty?
Eventually, the judge concluded that the real estate in question was acquired as a capital property, considering its nature, the taxpayer’s length of ownership, and her limited real estate endeavors.
However, the judge also noted the property was never occupied on a regular basis and there were “no identifiable changes of address, permanent hallmarks, or other domestic expenses and touches, beyond mandatory utilities,” thereby declaring it not her principal residence.
As a score for the CRA, the judge ruled on the third issue that because the taxpayer lacked “details and material to show reasonably that she may have been correct” in her filing position, the agency was within its rights to reopen and review the 2011 tax year, even after the customary reassessment period had expired.
But the judge ruled with the taxpayer in the fourth question, deciding that the taxpayer was not substantially negligent in claiming that the home was her primary residence and therefore the gain did not need to be recorded on her 2011 tax return.
“[The taxpayer], while educated, is clearly unfamiliar with the ways of business and tax. Her belief she could navigate the tax laws because it related to personally held real property was ill-founded. However, based on all the facts, it was not tantamount to a deliberate act, refined to indifference of compliance with the law,” the judge wrote in the decision.
Information for this briefing was found via Financial Post and the sources mentioned. The author has no securities or affiliations related to this organization. Not a recommendation to buy or sell. Always do additional research and consult a professional before purchasing a security. The author holds no licenses.