Speculation that the federal government could introduce a tax on the gain associated with your principal residence has quieted down in recent months, especially with a summer or fall election potentially on the horizon, so homeowners continue to sell — and benefit — from substantial tax-free gains on the sale of their principal residence.
But as regular readers will know, the Canada Revenue Agency in recent years has been cracking down on taxpayers who, in its view, are inappropriately claiming the principal residence exemption, particularly as it relates to flipping houses. If it’s determined that you’re regularly buying and selling homes, you can be denied the exemption and potentially be taxed on any profits as 100-per-cent taxable business income, versus a more palatable 50-per-cent taxable capital gain.
A recent case, decided earlier this month, involved a Vancouver taxpayer who purchased, demolished, constructed and then sold three homes in a six-year period. The taxpayer was appealing a 2019 decision of the Tax Court of Canada.
The case first went to trial in the fall of 2016, continued the following spring and lasted five days. The taxpayer from 2004 to 2010 had purchased three houses, demolished these houses, constructed new houses and sold them. The CRA reassessed the taxpayer for his 2006, 2008 and 2010 taxation years to include unreported net business income in respect of the sale of these properties. The CRA also assessed the taxpayer for unreported GST in relation to the property sales. Penalties were also assessed under both the Income Tax Act and the Excise Tax Act.
Although the taxpayer is a licensed real estate agent in Vancouver, during the taxation years at issue, he only reported modest amounts of income of between $15,000 and $20,000 per year as a realtor.
The three properties at the heart of this dispute have a similar fact pattern. The first property was purchased in 2004 for $580,000. After acquiring the property, the taxpayer obtained a demolition permit and tore down the existing house on the property. In 2005, he received a building permit to construct a new house on this property. He subsequently arranged for the construction of the new house, listed the property for sale in early 2006 and sold it in April for about $1.4 million.
The second property was purchased in June 2006, approximately two months after the taxpayer sold the first property. The purchase price for this property was $890,000. He proceeded to demolish the existing house and construct a new house on the land. The property was listed for sale in early 2008 and sold in March 2008 for almost $2 million.
The third property was purchased in August 2009 for about $1.1 million. The existing house was demolished and a new home was constructed on the property, which was sold in November 2010 for nearly $2.3 million.
At the Tax Court, the taxpayer argued he had acquired each property as a place of residence for himself and his son, and that he had occupied each property for a period of time before selling it. He then claimed that he sold each house because he felt that his debt was too high and he wanted to pay his debts.
Yet, shortly after selling each house, he incurred more debt than he had previously. The mortgage amount for the first house was $812,500, about $1.1 million for the second house and $2.1 million for the third house. As the appellate court would later remark: “A person who wants to reduce their debt would not incur more debt shortly after selling a house and paying off the previous debt.”
The taxpayer did not report the gains arising from the dispositions of these properties because he had assumed the houses would qualify as his principal residence and, therefore, be tax-free. Similarly, he did not report any GST liability on the three sales because he assumed he was not a builder for purposes of the Excise Tax Act and so he was not required to charge GST.
The Tax Court judge felt that the taxpayer’s “testimony was not credible” and that he “did not ordinarily inhabit any of the three homes for any period of time.” As a result, the judge concluded that the taxpayer could not claim the capital gains reductions that would apply if he had sold his principal residences.
“In my view,” the judge wrote, “it is abundantly clear from the evidence in this case that (the taxpayer) carried on the development of the three homes in the course of a real estate development business which he carried on as a sole proprietor, and that the profit he earned therefrom was accordingly earned on account of income.”
The Tax Court also found the taxpayer was considered a “builder of the residential complexes” and should have charged GST on each home sale.
The taxpayer appealed the lower court’s decision to the Federal Court of Appeal, which heard the case via online video conference in June 2021. The sole issue raised by the taxpayer before the appellate court was whether he satisfied the definition of a “builder” for the purposes of charging GST. This depended on the findings of fact and law made by the Tax Court judge as to whether the taxpayer was carrying on a business or an adventure or concern in the nature of trade.
The appellate court reviewed the tests to be considered in determining whether a gain realized on the sale of a property was an income gain or a capital gain: the nature of the property sold, the length of the ownership period, the frequency or number of similar transactions, the work expended on or in connection with the property, the circumstances that were responsible for the sale of the property, and, finally, the taxpayer’s motive. Prior jurisprudence called this latter test of motive, or the taxpayer’s intention, “a factor of utmost importance.”
After reviewing all the evidence, the appellate court’s three-judge panel unanimously ruled that there was “no basis to overturn the finding of the Tax Court judge that (the taxpayer) was carrying on a business in acquiring the properties, demolishing the existing dwellings, constructing new homes and selling them.” Thus, the taxpayer was considered a builder under the Excise Tax Act, and should have charged GST on the sales of each of the three homes.