In British Columbia’s booming real estate market, many individuals, including real estate agents, are engaging in property flipping — buying and reselling properties to turn around a quick profit. And this trend is not limited to completed homes, people are also flipping their “assignment sales” or buying and selling properties before their official sale or construction.
While you may recognize the term “property flipping,” you may not be familiar with its related tax obligations. The Canada Revenue Agency (CRA) requires you to report the money you make on all real estate transactions, including flips, assignment sales, and any fees or commissions generated on from these transactions.
TAX OBLIGATIONS FOR FLIPPED PROPERTIES
It is important to note that transactions related to property flipping may also be subject to GST/HST, which you would be responsible for remitting to the CRA, and that the principal residence exemption does not apply to property flipping. The CRA is taking action to address non-compliance in the real estate sector, and to ensure that the principal residence tax exemption is only claimed by those who are eligible for it.
But one of the most important things Canadians must be aware of with regards to property flipping is that their profits from real estate will fall under one of two categories: capital gains or business income. In the case of capital gains, only 50 per cent of the profit is taxable, whereas 100 per cent of business income is subject to tax.
The profits you make from flipping real estate are generally considered to be fully taxable as business income, as these properties are not considered capital property. Here are three things to keep in mind to help you determine whether your profit should be considered business income or a capital gain:
- The Normal Course of Business
If the transaction is similar to your normal course of business, it may be considered business income.
- The Frequency of the Transaction
The more frequently you engage in property flipping transactions, the more likely the CRA will consider it on account of business.
- The Adventure in the Nature of the Trade
Income from an adventure or concern in the nature of trade is treated like business income. If what you are doing is an “adventure in the nature of trade,” an activity that realizes a profit but is unrelated to your primary business activities — then your gain will be fully taxable.
While The Income Tax Act does not list criteria to distinguish when profits are taxed as business income rather than a capital gain, the case law has developed a number of factors that are generally taken into account in making this determination. Some of these factors are mentioned above, and others include the following:
- the nature of the property sold;
- the length of time the property was owned;
- the frequency and number of real estate transactions a person carries out;
- the improvements made to the property (if any);
- the circumstances surrounding the eventual sale of the property; and
- the intention at the time the property was acquired.
As an example, one taxpayer found herself in Tax Court fighting CRA reassessments related to multiple tax years during which she disposed of six real estate properties, realized total profits of more than $100,000, and reported the profits as taxable capital gains. The CRA argued that the transactions should be treated as business income and should be fully taxable.
The taxpayer argued that she wanted to keep the real estate as rental properties for her retirement portfolio. However, she reported significant rental losses in two of the tax years, the average holding period of five of her properties was nine months, and she had financed her properties using one-year mortgages. She claimed she sold explanation that the reason behind her selling the properties due to low rental rates, but the CRA was not convinced with the argument, given her real estate experience.
The judge concluded that the taxpayer acquired the properties for the main purpose of reselling them at a profit rather than holding them as long-term investments. As a result, the taxpayer had to pay the full tax on the profits as business income, not as fifty percent taxable capital gains. Using the criteria above, it’s likely that any profits enjoyed by those real estate agents who flip houses would be fully taxable as business income.
Consult a chartered professional accountant for advice based on your individual situation.