Real Estate – Tax Treatment

In this article, we will explore the following:

• Principal Residence Exemption

• Capital gains on real estate

• Property Flippers.

Designating a Property your Primary Residence

You are exempt from paying taxes on the sale of a property if it is your primary residence. For a property to be considered a primary residence, you or your family must have “ordinarily inhabited” the property. You may designate one property per year as your primary residence. There is no specific length of time you must live in the home for it to be considered “ordinarily inhabited.” Since the 2016 tax year, you must list the sale details, even if the primary residence exemption fully protects the property.

When you list the sale of the property on your taxes, the CRA will consider several factors when deciding whether a property should rightfully be regarded as a primary residence. The tax authorities will consider the following:

• the intent at the time of purchase

• the timeframe between the purchase and sale,

• The number of purchases and sales a person has made, the number of primary residence designations a person has made, etc.

If you fail to report your profits accurately and the CRA finds out about it, you could be charged penalties and interest on the tax owing, so speak to a tax professional for advice if needed. Therefore it is essential that you report everything accurately. Otherwise, you may receive an unexpected tax bill.

To claim the residential tax exemption, you must report the disposition and designate the property as your principal residence on Schedule 3 of your income tax return, i.e. Capital Gains (or Losses). The exemption allows you any profit gained from the sale tax-free.

Taxes for Flipping houses

Property flippers buy and resell homes in a short period for a profit (i.e. they treat homes as inventory).

Understanding that profits from flipping property are treated as Business Income is essential.

Flipping a house (buying a home, renovating it, and reselling it) can make you quite a lot of money with the right renovations and in the right real estate market.

It is imperative to understand the tax implication of flipping; the profit is considered 100% taxable. Assuming that you are in the highest bracket in Ontario, for the sake of simplicity, it is 50%.

Some examples of property flipping are listed below:

• Purchasing a property, renovating it and then reselling it at a profit.

• Purchasing a pre-construction property and reselling it for a profit when the project is complete.

• Purchasing pre-built condos from a developer and then selling them at a profit before taking possession of the property (a kind of “shadow flipping”).

Understanding the tax implications for property flippers is critical to budget accordingly and what you will take home.

There are HST implications which are not covered in this article.

Capital Gains versus Business Income

In most cases, you will be charged taxes if you sell a property that is not your primary residence. However, how much you are charged will depend on whether the CRA considers the profits to be business income or capital gains.

The most significant difference between capital and business profits is the rate of tax payable. If the sale of a property is deemed to be capital in nature, only 50% of the gains are reported on your T1 General tax return. However, if the sale is considered part of a business, you will be taxed on the entire amount.

Example:

You purchased a single-family home for 500,000 and invested 50,000 in renovations to turn it into a beautiful home. You sell the house for 650,000. What happens to the profits? Therefore the profits of 100,000 (650,000 sale price minus 500,0000 costs minus 50,000 renovations), CRA will likely treat the 100,000 as business income and subject the entire amount to taxation.

If it’s treated as Business Income, then the entire 100,000 will be taxable. If it’s treated as capital gain, only 50% of the 100,000 (i.e. 50,000) would be taxable.

Factors that CRA Considers to determine Business Vs. Capital Gains

There are several factors.

• If the CRA believes you purchased the property to sell it for a profit, they will likely consider it business income.

• Much like how the CRA determines whether or not a property is your primary residence, the agency will look at how many properties you’ve bought and sold, how often you’ve done this,

• the nature of the renovations,

• the timeframe of the purchase and sale,

• and many other factors.

• The CRA will also look at your profession when determining whether it considers the profits of a sale to be business income. If you are a builder or contractor or have a similar profession, it’s more likely that the CRA will consider your profits as business income and charge you as such.

Therefore understanding the various dynamics of business vs. capital is imperative.

Contact us for a consultation.

The content of this blog is intended to provide a general guide to the subject matter. Professional advice should be sought about your specific circumstances.

By: Kamal Gawri, CPA, CA