Toronto Condos

Taxpayer who flipped a property eight years ago gets a CRA call

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.

Jamie Golombek, FCPA, FCA, CFP, CLU, TEP, is the managing director, Tax & Estate Planning with CIBC Private Wealth in Toronto.

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Following a weak second half of 2023, home sales over the last two months are showing signs of recovery, according to the latest data from the Canadian Real Estate Association (CREA).

Home sales activity recorded over Canadian MLS® Systems rose 3.7% between December 2023 and January 2024, building on the 7.9% month-over-month increase recorded the month prior. While activity is now back on par with 2023’s relatively stronger months recorded over the spring and summer, it begins 2024 about 9% below the 10-year average. (Chart A)

“Sales are up, market conditions have tightened quite a bit, and there has been anecdotal evidence of renewed competition among buyers; however, in areas where sales have shot up most over the last two months, prices are still trending lower. Taken together, these trends suggest a market that is starting to turn a corner but is still working through the weakness of the last two years,” said Shaun Cathcart, CREA’s Senior Economist.

Highlights:

National home sales were up 3.7% month-over-month in January.

Actual (not seasonally adjusted) monthly activity came in 22% above January 2023.

The number of newly listed properties edged up 1.5% month-over-month.

The MLS® Home Price Index (HPI) fell by 1.2% month-over-month but was still up 0.4% year-over-year.

The actual (not seasonally adjusted) national average sale price posted a 7.6% year-over-year increase in January. National gains were once again led by the Greater Toronto Area (GTA), along with Hamilton-Burlington, Montreal, Greater Vancouver and the Fraser Valley, Calgary, and most markets in Ontario’s Greater Golden Horseshoe and cottage country.

The actual (not seasonally adjusted) number of transactions came in 22% above January 2023, the largest year-over-year gain since May 2021. That said, with current activity still running at below-average levels, the double-digit gain was more reflective of the base effect from the comparison to January 2023, which was the worst start to almost any year in the past two decades.

The number of newly listed homes edged up 1.5% on a month-over-month basis in January, although it remains close to the lowest level since last June.

“The market has been showing some early signs of life over the last couple of months, probably no surprise given how much pent-up demand is out there,” said Larry Cerqua, Chair of CREA. “There’s a consensus that the market will probably look quite a bit different this year compared to 2022 and 2023, so if you’re hoping to buy or sell a property in 2024, contact a REALTOR® in your area and get your game plan ready today,” continued Cerqua.

With sales up by more than new listings in January, the national sales-to-new listings ratio tightened further to 58.8% compared to under 50% just three months earlier. The long-term average for the national sales-to-new listings ratio is 55%. A sales-to-new listings ratio between 45% and 65% is generally consistent with balanced housing market conditions, with readings above and below this range indicating sellers’ and buyers’ markets respectively.

There were 3.7 months of inventory on a national basis at the end of January 2024, down from 3.8 months at the end of December and 4.1 months at the end of November. The long-term average is about five months of inventory.

The Aggregate Composite MLS® Home Price Index (HPI) fell by 1.2% on a month-over-month basis in January 2024. This represented an acceleration from the 1.1% decline recorded in December.

Price declines of late have been predominantly located in Ontario markets, particularly the Greater Golden Horseshoe and, to a lesser extent, British Columbia. Elsewhere in Canada prices are mostly holding firm or in some cases (Alberta and Newfoundland and Labrador) continuing to climb.

The Aggregate Composite MLS® HPI was up 0.4% on a year-over-year basis in January 2024, little changed from readings over the last six months (0.4% - 1.1%). (Chart B) The actual (not seasonally adjusted) national average home price was $659,395 in January 2024, up 7.6% from January 2023.

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