If you are a professional contractor or renovator, a speculator or middle investor, or an individual renovator the CRA is paying close attention to your property sales and need guidance on the tax obligations related to your real estate investments
Published: July 30, 2019
Updated: July 30, 2019
The Canada Revenue Agency (CRA) often focuses its audit efforts on the real estate sector by regularly monitoring tax compliance on real estate transactions. The CRA's focus is largely driven by the fact that audits in the real estate industry are a significant source of tax revenue.
The Government of Canada recently reported that “since 2015, CRA audits have identified over $1 billion in additional gross taxes related to the real estate sector.” In 2018, the CRA assessed $171 million more in additional gross taxes related to real estate, a 65% increase when compared to 2017, while penalties totaled over $57 million.
The CRA's focus―real estate transactions
The CRA's focus is not about to change, at least not any time soon. The 2019 federal budget proposed to provide the CRA with $50 million over five years starting in 2019, and $10 million ongoing, to create a Real Estate Task Force. The task force will initially focus on the greater Toronto and greater Vancouver areas, “following the risk as it evolves over time.” With the help of auditors and business-intelligence officers with specific knowledge, training, and expertise, the CRA promises to enhance its ability to detect, and take action whenever it finds, real estate transactions in which parties have failed to pay the required taxes.
The CRA's primary focus
The 2019 federal budget stated that CRA audit teams will use advanced risk-assessment tools, analytics, and third-party data, and that the teams will collaborate with the provinces and territories to share information. The audit teams will work to make sure that tax provisions are followed, focusing on ensuring that:
- taxpayers report all sales of a principal residence on tax returns;
- capital gain derived from a real estate sale in which the principal-residence tax exemption does not apply are identified as taxable;
- money made on real estate flipping is reported as income;
- commissions earned on real estate transactions are reported as taxable income; and
- builders of new residential properties remit the appropriate amount of tax to the CRA for Goods and Services Tax/Harmonized Sales Tax (GST/HST) purposes.
The expected revenue from the initiative is $68 million over five years, starting in 2019.
Let's take a closer look at the CRA's focus and how it may impact you.
Reporting the sale of a principal residence
The principal-residence exemption is an income tax benefit that generally provides a taxpayer with an exemption from tax on the capital gain realized when a property that is a principal residence is sold. The exemption applies for each year the property is designated as a principal residence.
It is imperative that taxpayers are compliant with the rules for reporting the sale of a principal residence. You are required to complete Schedule 3 and file it with your income tax return for the year in which you sell a property, if the property was your principal residence for every year that you owned the property. The year of acquisition, proceeds of disposition, and the description of the property are the information that you must report to the CRA. If the property was not your principal residence for every year that you owned it―for instance, a different property, such as a cottage, was designated as your principal residence for one of the years during the period of ownership―Form T2091 (IND), Designation of a property as a principal residence by an individual (other than a personal trust), has to be filed with your income tax return, and you have to determine the capital gain that is taxable.
Reporting capital gains
If you realize capital gain on the sale of real estate, you must report it on Schedule 3 and file it with your income tax return. Remember, if you own more than one property at any given time, only one property is eligible for the principal residence capital gains exemption for any given tax year at the time of sale.
Reporting income from property flipping
Property flipping occurs when people buy and resell homes within a short period of time for a profit. Flipping property is not illegal. The Canada Revenue Agency wants taxpayers to know that income from these transactions must be reported to them, however. The CRA has found that some property flips are not reported at all or are reported incorrectly. Profits from flipping real estate are generally considered to be fully taxable.
While the facts of each case determine whether profits should be reported as business income or as a capital gain, the CRA considers there to be three main categories of taxpayers engaged in flipping:
Often buy and sell real estate at a profit (usually after renovating the property).
Often buy a property before construction is completed, then assign the right-to-sell clause in the contract to another speculator or to the final buyer.
Often buy real estate, renovate it, and live in it for a short time before selling it for a profit and claiming the principal-residence exemption.
Reporting earned commissions
If you are a real estate agent who is an employee, you must report the total commissions shown on all of your T4 slips on your income tax return. On the other hand, if you are a self-employed real estate agent you will need to know your gross and net commission income and enter it on your income tax return. The CRA provides guidance on their website for determining whether a real estate agent is an employee or a self-employed worker.
GST/HST issues in real estate
Builders face many technical GST/HST challenges due to the complexity of the rules applying to the construction and sale of real estate―particularly in the case of newly constructed residential property. Builders collect and remit GST/HST on the sale of new residential units and the buyer, if eligible, may be entitled to a new residential homebuyer's rebate. If a builder converts the use of a newly constructed residential complex to long-term rental use, the GST/HST rules put non-recoverable GST/HST in the hands of the builder based on the based on fair market value (FMV) of the residential complex. Where the individual rental units qualify, the builder may be entitled to a residential-landlord rebate. The self-assessment and rebate rules are complicated, imposing tax, interest, and penalties on the builder, if not reported correctly.
The financial risk associated with incorrectly reporting GST/HST is particularly acute for builders of large rental-development projects involving tens of millions of dollars in FMV (or more). Other GST/HST rules posing risk to builders include those focused on properties constructed on leased land, where the purchaser is buying a newly constructed residential house or condominium unit together with an assignment of the underlying lease of the land. They also include rules focused on small- and mid-sized builders who partially renovate properties―these builders are restricted from claiming input tax credits (ITCs), which may come as a surprise if the property is sold on a GST/HST-exempt basis because the residential property was not substantially renovated. These are just a few of the GST/HST issues and rules that will continue to be the focus of increased CRA audit activity.
Returns selected for audit
The CRA has recently intensified compliance efforts in the real estate sector, particularly in areas where speculative activity has increased. If your return is selected for audit, the CRA have identified factors they consider when determining whether you correctly reported a real estate sale:
- the type of property sold
- how long you owned it
- your history of selling similar properties
- whether you did any work on the property
- why you sold the property
- your intention in buying the property
The information in this publication is current as of June 30, 2019.
This publication has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The publication cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact BDO Canada LLP to discuss these matters in the context of your particular circumstances. BDO Canada LLP, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information in this publication or for any decision based on it.