To discourage speculation in the housing market, the 2022 federal budget introduced anti-flipping rules for residential real estate (including rental properties) that came into effect Jan. 1, 2023, and were designed to “reduce speculative demand in the marketplace and help to cool excessive price growth.”
The rules prevent you from claiming the principal residence exemption to shelter the capital gain realized on the sale of your home if you’ve owned it for less than 12 months, and they tax the gain on the sale of any residential real estate as 100 per cent taxable business income, subject to certain exemptions for life events such as death, disability, separation and work relocation.
Although the rules only came into play for 2023 and future years, the Canada Revenue Agency can still challenge real estate “flips” that took place prior to 2023 if it feels a taxpayer has speculated and flipped a property for a quick profit.
Take the case decided last month that involved an Alberta taxpayer who was reassessed for his 2016 taxation year for failing to report the profit he made on the disposition of a property in Calgary.
In 2016, the taxpayer was a real estate associate who was involved in various property transactions. One of the properties he owned was a two-bedroom, one-bathroom bungalow with a detached two-car garage, which the taxpayer held from Oct. 20, 2016, to Nov. 21, 2016 — a period of 33 days. During this time, the taxpayer never listed the property for rent and he ended up selling the property for a gain of nearly $73,000, which he did not report on his 2016 personal tax return.
Because the CRA only reassessed the taxpayer for the unreported 2016 sale in 2021, the first issue before the Tax Court was whether the agency was permitted to reassess him beyond the normal three-year reassessment period. To do so, the CRA must generally demonstrate, on a balance of probabilities, that a taxpayer made a misrepresentation attributable to “neglect, carelessness or willful default or committed fraud” in filing their tax return.
In this case, the CRA wasn’t alleging that the taxpayer committed fraud, but the agency felt there was a material misrepresentation on the taxpayer’s 2016 tax return since the gain wasn’t reported.
The taxpayer said he didn’t declare the property sale on his return because his “expenses have erased any possible gain,” but the judge wasn’t buying that explanation and said “a misrepresentation was clearly made” when the taxpayer filed his 2016 return, and it was done “through negligence or at least carelessness or wilful default.” Thus, the CRA was permitted to reassess the taxpayer’s 2016 tax year beyond the normal reassessment period.
In court, the taxpayer said that, at the very least, he should be entitled to capital gains treatment, meaning that only 50 per cent of the gain is taxable. (For individuals, the capital gains inclusion rate is set to increase to two-thirds for gains of more than $250,000 on or after June 25, 2024.)
The taxpayer also said his gain should be reduced to $12,467 (from $73,000) to take into account two additional expenses that he introduced as evidence at the hearing. The first was a referral fee of $40,500 paid to an Alberta numbered company that the taxpayer owned 50-50 with his business partner, and the second was a referral fee of $20,000 paid to his partner’s spouse. Both referral fees were paid in connection with the sale of the property, he said.
The judge, however, was not convinced that, “on the balance of probabilities,” the additional $60,500 of expenses were appropriately deducible against the gain. “The documents are far too ambiguous, vague, unclear and unreliable as to the true nature of the payments made at closing,” he said in disallowing the expenses.
The remaining issue regarding the sale of the property was whether the $73,000 gain was to be taxed as a capital gain or income. Because the taxpayer didn’t report the disposition at all in his 2016 tax return, the court was forced to solely rely on the evidence presented at trial to determine whether the income account treatment alleged by the CRA should stand. On this point, the taxpayer didn’t elaborate, except to maintain that he wanted to rent out the property.
But the judge, citing the financing structure used to purchase the property, the circumstances leading the taxpayer to buy it in the first place, the “immediate and prompt renovation” of the main floor and the basement, and the taxpayer’s experience as a real estate agent, was not convinced that the real intent of the taxpayer when he bought the property was to rent it out.
“The court finds it hard to believe that the (taxpayer) was faced with so many events in such a short period of time that the only option was to sell the property quickly and make a profit of approximately $70,000, all in one month of ownership,” the judge said. “The (taxpayer’s) motivations in this project deserve more credit.”
In the end, the judge concluded that the taxpayer’s testimony was insufficient to support a recharacterization of the gain realized on the sale of the property as a capital gain, and upheld the CRA’s reassessment of income treatment.