Profit From Flipping Homes In Canada Now Taxed As A Business

ID-100206797Is flipping homes a business or is it capital? I’ve been talking about this for many years about how this is a big mistake that people have been making.

When you buy real estate, the intent behind the acquisition is very important and documenting that intent is even more important. If you are buying a pre-built condo and your intention is to sell it the day it opens up, you’re now in the business of buying and selling real estate and that is not a capital increase – that is an act of business.

Revenue Canada is starting to crack down on these cases and if you aren’t aware of the rules, you could be getting a big tax bill in the mail if you sell too quickly.

An Extreme Scenario

CBC News released a report discussing a case with an 84-year-old lady that had purchased a condo prior to it being built. Unfortunately, a lot changed in the three years between the time of purchase and when the condo was ready for move-in.  In addition, the elderly woman’s health required more attention. She ended up moving to a retirement home and the condo was sold at a profit.

The result?

The CRA says that she owes a large amount of money to cover the taxes associated with the profit on her business venture. An interesting question would be if that 84-year-old woman would have been eligible for the principal residence exemption if that was her only residence during that period of time.

It’s possible but if you look at the rules, they state that you have to live in the residence for at least a year prior to sale for the property to qualify as a principle residence. It’s pretty tough to live in something that doesn’t exist yet!

What Is The Intention?

If you take a look at business real estate transactions, they can be treated as business income, capital disposal and a portion in between.

If the property in question is a principal residence, there is another level of discussion that needs to occur. It’s the intention when you acquire the property that is so important when purchasing.

If you are purchasing a piece of property and your intention is to sell it for a profit, that is considered business income.

What About Lease-To-Own?

I recently met with a client that came to talk to me because he has three lease-to-own buildings. Is that business income or is that capital? If you are in the business of lease-to-owns, it’s business income, not capital. The appreciated value of that property is NOT going to be capital; it’s going to be income.

This is where the expensive mistakes happen.

Income Vs. Capital Disposal

It is so incredibly important that you document all relevant information when you acquire a property. Document why and when you’re selling and be consistent in the way that you treat that property going forward. It’s always been known that realtors are in the business of real estate so it’s very difficult for them to argue against money not being income from buying and selling real estate.

There’s no hard and fast rule – if I buy a rental property and my intention is to buy it, hold it, rent it and then sell it down the road, that would be considered a capital disposal.

But what happens if I buy it, rent it and then the tenant says they want to buy the house? If you’ve documented your intention, completed your business plan and are able to show that your intention was to hold it long term until something changed, I can argue that this was a capital disposal.

Crossing The Line

Now let’s say your intention is to buy and hold the property but you happen to do five buy and holds throughout the year that ended up selling. Even though your documentation says you weren’t going to sell them it is very easy to decipher that the evidence demonstrates your true intention..

Do not try to make documentation that is false.

If you are doing multiple transactions, it becomes less and less likely that the transaction is a capital disposal.

How To Properly Document Your Intention

How do you document your intention? First, you start with creating a real estate business plan for your family that clearly outlines your intentions and what exactly your business is. For example, if I am in the rental business, I would show how it makes sense for me to buy the property, hold it and rent it because it creates positive cash flow. It makes business sense to buy and hold so I’m going to buy 5 properties using this particular model, for sake of example.

During the period of time owning rentals, it’s not unusual to sell the odd one. Just because you sell the odd one doesn’t make it business income, that’s not the guideline.

The guideline is that you really have to look at the facts and the intention.

Proper Documentation Will Prove To Be Useful

Sometimes the situation is a bit wishy washy and it’s in between – you might not be sure which way is which. This is where you need better documentation. It’s easy if it’s cut and dry but you do have to make sure that you do your documentation. Also, if circumstances change causing you to adjust your plan, document this.

It’s very difficult for a CRA auditor to look at a piece of paper that’s 5 or 10 years old and argue that it wasn’t your intention. That said, never lie about your intention just to try and get capital disposal status. If that’s not your intention, the professionals will see right through it.

As a general rule of thumb, the more times you sell a property, the more times that you’re going to have the potential that it will be considered income vs. capital.

Still Confused? Ask Yourself These Questions:

  • Is this the first time you’ve flipped a property?
  • Are you planning to flip properties more often? It’s not considered capital disposal just because it’s the first one.
  • What is truly the reason why you are doing this? Document it.

If you are still confused, feel free to reach out to me directly. I provide real estate advisory services for investors like you every day and would be happy to help get you on the right track.

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