Selling real estate? The CRA is (still) watching

As 2023 begins, real estate investors should know that the Canada Revenue Agency (CRA) continues to watch real estate transactions for the purpose of curbing tax non-compliance.

From April 2015 to March 2022 in Ontario and British Columbia, CRA audits identified over $2 billion in additional gross taxes including assessed penalties totalling over $299 million.

At the same time, housing affordability in Canada has trended downward, and the 2022 federal budget contained a number of measures to address housing concerns. From a tax perspective, the measures included a new property flipping rule, now in effect, to ensure that profits from flipping residential real estate are properly reported as business income.

Property flipping — the buying and selling of homes in a short period of time for a profit — is not illegal. Canadians have the right to purchase and sell property for a profit. However, the CRA requires income from these transactions to be reported — and reported correctly.

When an individual sells real estate, the profits can be non-taxable, taxed as a capital gain (based on a 50% inclusion rate) or fully taxable as business income. The circumstances surrounding the purchase and sale of the property determine how the profits are taxed (read one of my previous articles for more about this). When an investor buys a property with the intention to improve and sell it for profit, the transaction is normally referred to as a property flip, the profits from which are fully taxable as business income.

The Department of Finance is concerned that individuals are not correctly reporting profits from property flips; sometimes the profits are being reported as tax-efficient capital gains, while other times the principal residence exemption is claimed in an attempt to shelter the profits from tax.

To correct this, for property sales on or after Jan. 1, 2023, profits arising from dispositions of residential property (including rental property) owned for less than 12 months would be deemed to be business income for tax purposes. There are exceptions for certain life events, including death, birth, separation, disability or illness, and employment change. Where the deeming rule does not apply (perhaps because of an exempted life event or because the property was owned for 12 months or more), the circumstances would dictate if related profits should be taxed as business income.

Property flippers would be wise to become familiar with the above rule to avoid penalties and interest from incorrect reporting. The rule change might also cause a cooling of the housing market as speculative buyers consider the cost of their transactions.

Having said that, all sellers of real estate should know that the CRA continues to watch real estate transactions, with specific areas of concern detailed below.

Reported income does not support lifestyle: The CRA considers whether income reported on tax returns is sufficient to support a taxpayer’s lifestyle, including the cost and maintenance of real estate. The CRA can establish correlations between a taxpayer’s reported income and their lifestyle.

Property flipping: The CRA acquires and analyzes third-party data to determine if property flips are being reported correctly.

Unreported capital gains on the sale of property: Profits from certain property sales are taxable as a capital gain (e.g., sales that are not from property flips or part of a business venture). All capital gains, exempt or not, must be reported on the seller’s income tax return. If more than one property is owned at any given time, only one property is eligible for the principal residence exemption for any given tax year.

Unreported capital gains on property sold by a non-resident: Non-residents who invest in property in Canada must pay capital gains tax on profits from the sale of the property, and the property is not normally eligible for the principal residence exemption.

To avoid liability, a purchaser who buys property from a non-resident seller should request, from the seller, a certificate of compliance issued by the CRA before releasing funds for the purchase. The certificate confirms that the CRA has received acceptable tax or security from the seller in respect of the sale.

Unreported worldwide income: Canadian residents must report worldwide income to the CRA. Non-residents report only Canadian-source income.

Unreported GST/HST on the sale of a new or substantially renovated home: Generally, the builder of a new or substantially renovated home must collect GST/HST when the home is sold and remit the tax to the CRA. In most cases, the sale of used housing is exempt from GST/HST.

Tax rebates available to the builder or purchaser: Purchasers of a new home may be entitled to GST/HST rebates if the intention is to live in the home as a principal residence, or lease or rent it. If, however, the intention is to flip the property, rebates may not be available.

Conclusion

Using risk-assessment tools, analytics and third-party data to detect and address non-compliance, the CRA will apply a penalty equal to 50% of the additional tax payable if a taxpayer knowingly makes a false statement when filing a tax return.

And, for those who purposely report transactions incorrectly thinking that the CRA will never find out, it’s important to know that the CRA’s Leads Program is alive and well. The program serves as a way for people to anonymously snitch on those they suspect have not fully reported their incomes. So, let your client know that the CRA continues to watch their real estate transactions.

Wilmot George, CFP, TEP, CLU, CHS, is vice-president, Tax, Retirement and Estate Planning with CI Global Asset Management. Wilmot can be contacted at wgeorge@ci.com.

Wilmot George

Tax & Estate

Wilmot George, CFP, TEP, CLU, CHS, is vice-president, Tax, Retirement and Estate Planning at CI Global Asset Management. Wilmot can be contacted at wgeorge@ci.com.