In recent years, prices in the Canadian housing market have been increasing rapidly. One of the reasons for this excessive price growth is believed to be an increase in speculative “property flipping” activities where a house is purchased and then sold for a higher amount in just a short period of time.
In an effort to turn down the heat on the housing market and make homes more affordable, the Federal government has approved new legislation to implement residential “anti-flipping” tax rules. The goal of these new rules is to ensure profits from residential property flipping are subject to full taxation as business income as opposed to eligible for the preferential capital gains inclusion rate or the principal residence exemption which may discourage some taxpayers from these transactions.
The new “anti-flipping” tax rules will apply to residential properties sold on or after January 1, 2023.
Previous Rules
Prior to 2023, there was no specific legislation to determine whether the profit on the sale of a residential property should be treated as a capital gain or business income. Instead, the Canada Revenue Agency (“CRA”) would consider various factors supported by case law when deciding on the type of income including:
- The taxpayer’s intention regarding the property at the time of purchase;
- The nature of the business, profession, calling, or trade of the individual and their associates;
- The extent to which borrowed money was used to finance the acquisition and the financing terms arranged;
- The length of time the real estate was held; and
- The factors motivating the sale.
Depending on the result of the above analysis, the CRA could take the position that the profit is fully taxable as business income and reassess the taxpayer accordingly.
New Rules
Effective January 1, 2023, under new subsection 12(12) of the Income Tax Act (“ITA”), the gain on the disposition of a “flipped property” will be fully taxable as business income. Additionally, no principal residence exemption will be available to reduce the tax arising from the sale of the property.
The term “flipped property” is now defined in the ITA and will generally include a residential property (or right to such property) that is located in Canada and owned by the taxpayer for less than one year.
Exceptions
There are several exceptions to the new rules, which generally address the situation where the sale of a property can be reasonably considered to occur due to one or more of the following “life events”:
- The death of the taxpayer or a person related to the taxpayer;
- A related person joining the taxpayer’s household or the taxpayer joining the household of a related person;
- The breakdown of marriage or common-law partnership of the taxpayer if the taxpayer has been living separate and apart from their spouse or common-law partner for at least 90 days prior to the disposition;
- The threat to the personal safety of the taxpayer or a related person;
- The taxpayer or a related person suffering from a serious illness or disability;
- An “eligible relocation” of the taxpayer or spouse or common-law partner;
- The involuntary termination of employment of the taxpayer or their spouse or common-law partner;
- The insolvency of the taxpayer; or
- The destruction or expropriation of the property against the taxpayer’s will.
Accordingly, if one or more of the above situations are applicable, the residential property may not be considered a “flipped property” and these new rules should not apply.
Conclusion
Where a residential property is bought and sold within a year, these new “anti-flipping” tax rules provide CRA with a “bright-line test” whereby it will be assumed that the property is a “flipped property” and the profits will be taxed as business income, unless one of the above exclusions can be reasonably considered to apply.
It is important to keep these new rules in mind as the CRA has increased the number of audits relating to these types of transactions and non-compliance may lead to penalties and interest charges. Specifically, if the gain is incorrectly reported as a capital gain rather than business income, the taxpayer could be assessed a gross negligence penalty equal to 50% of the additional taxes owing, in addition to interest charges.
Note also that even where the new residential property flipping rules do not apply to the gain on a disposition, the above case law factors should still be considered to determine the appropriate tax treatment.
Additional GST/HST implications may also need to be considered on the sale of a residential property such as in the situation where the property has undergone a “substantial renovation”.
For further guidance on the impact of the new “anti-flipping” tax legislation on your current situation, please contact your Welch LLP advisor.
Author: Destiny Hansma, Senior Staff Accountant
