If you have ever watched a reality show about flipping houses, it’s hard not to be impressed by the whopping profits they claim. Who wouldn’t want to buy a fixer-upper and sell it for a huge gain? Before you jump in and buy that house down the street that has “so much potential”, you must first consider the tax implications.
Property flipping is when individuals, including real estate agents, buy and resell homes in a short period of time for a profit. This also includes buying and selling a property before its official sale or construction—a process called an “assignment sale” but sometimes also referred to as “shadow flipping”.
Capital Gain versus Business Income
The biggest difference between capital profits 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 as income on Line 12700 – Capital Gains. However, if the sale is considered to be part of a business, you must complete the T2125 – Statement of Business or Professional Activities and the entire net profit is subject to tax.
Let’s say you buy that little bungalow on the corner with the intention of selling it for a sizable profit. In a few short weeks, you’ve turned that handyman special into a dream home. According to your realtor, you stand to make $20,000 if the house sells before your next bank payment is due. Due to the circumstances surrounding the purchase and sale, CRA will likely treat that $20,000 as business income and subject the entire amount to taxation.
If you had purchased that same house as a rental property, your profits from an eventual sale would most likely be considered capital gains. While the rental income you’d made would play a part in the calculation of the tax, you would only be taxed at the 50% rate. The difference is the intention. If you purchase a property with the intention of making a profit from its sale, it’s usually considered to be business income. If your intention is to have the property generate an ongoing income, it’s usually considered capital.
Intent is not the only factor CRA takes into account when it comes to capital versus business income. The number of properties you’ve sold, the timeframe between the purchase and sale, and the nature of the renovations are also considered.
But Isn’t It Exempt if I Live There?
If you sell your home, you are generally exempt from capital gains tax if the home was your principal residence. When house flipping first became popular, many people took advantage of this rule, thinking they were outsmarting CRA by avoiding potential tax implications. They claimed the project house as their primary residence during the renovation period and once the property was sold, they would simply change their address to the newest project home.
It didn’t take long before CRA put the lid on this practice by imposing stricter requirements for primary residence designation. Again, the intent at the time of purchase, number of purchases and sales, and the timeframe between principal residence designations are all considered when determining the exemption. The CRA is taking action to address non-compliance in the real estate sector and to ensure that the principal residence tax exemption is claimed only by those who are eligible for it. In addition to the tax owed on the sale, you may also be subject to penalties if you do not report your profits correctly.
This CRA link has more information: Flipping houses or condos? Know your tax obligations!
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