Given the financial significance of a purchase and sale of housing property, including a principal residence, it is important to understand the income tax implications of these transactions. If you sold residential real estate in Canada in 2023, you should know that the new residential property flipping rule could have an unexpected impact on your income taxes.
In this article, we will discuss the income tax implications of a sale of residential real estate, including what the new rule entails, important factors to consider, and documentation to retain if the Canada Revenue Agency (CRA) were to audit this transaction.
What is the residential property flipping rule?
Property flipping involves the purchase of real estate with the intention of reselling it for profit in a short period of time. The new residential flipped property rule was enacted in response to the government’s concern that certain individuals who were engaged in property flipping were inappropriately reporting the profits as a capital gain and, in some cases, claiming the principal residence exemption.
Under the new flipped property rule, a gain from the disposition of a residential property in Canada after 2022 that was owned for less than 365 days is considered to be fully taxable as business income regardless of intention. This means that the gains from such dispositions would not be eligible for the 50% capital gains inclusion rate or the principal residence exemption. Note that a right to acquire a housing property, such as the purchase of a pre-construction condo, is also caught under this rule— meaning that where the sale of such a right occurs within 365 days, the gain on the disposition would also be considered as business income.
Where this new rule applies, reasonable expenses that were incurred to earn income would be tax deductible, but any resulting loss would be denied and cannot be claimed as a business loss.
There are exceptions to the new rule that apply if the sale is due to certain life events such as death, marital breakdown, addition of family members, disability, eligible work relocation, involuntary termination of employment, insolvency, threat to personal safety, or destruction or expropriation of the property.
Where the flipped property rule does not apply
In cases where the new rule does not apply, such as when you owned the property for over a year or an exception applies, the facts of your situation will need to be examined to determine whether the gain on disposition would be taxable as business income or a capital gain. The issue becomes whether the real estate transaction is:
- “an adventure or concern in the nature of trade,” which would result in business income;
- part of a pattern of buying and selling real estate for profit, which would also result in business income; or
- capital in nature, which would give rise to a capital gain.
Where the disposition results in a capital gain, only 50% of the gain would be taxable. If the property qualifies as your principal residence, you may be able to use the principal residence exemption to reduce or eliminate the capital gain and the associated income tax on the sale.
Factors established by the courts
The flipped property rule takes away intention and most other factors that would normally be considered when determining if a disposition of real estate is on income or capital account. It does this by imposing an arbitrary 365-day rule. However, the issue of whether a disposition of residential real estate results in an income gain or a capital gain is based on long-standing criteria as a result of many court cases over the years.
In this regard, the courts have established a set of factors to determine whether a gain on a disposition of property is on income account or capital account, including:
- The taxpayer’s intention at the time of purchase, where an intention to sell the housing property for profit would likely result in the gain being considered on income account.
- Feasibility of that intention and the extent to which it was carried out.
- Length of time the real estate was held, where a quick resale would suggest that the gain would be on income account.
- Nature of the business or profession of the taxpayer, where the more closely related it is to the real estate industry, the more likely the gain on a sale would be considered business income.
- Factors that motivated the sale.
- Frequency or number of real estate transactions.
While this is not an exhaustive list, it is important to recognize that each factor is not conclusive, and the relevance of any particular factor will depend on the facts of each case.
CRA audits and documentation to retain
The CRA regularly conducts audits related to real estate and has increased compliance efforts in recent years, particularly in areas where speculative activity has increased. This includes major centres such as the Greater Toronto Area and the Lower Mainland in B.C.
Given the CRA’s increased focus on real estate transactions, if you’ve purchased and disposed of residential property in Canada, you should be prepared to support your filing position. If one of the exceptions to the new flipped property rule applies, be sure to maintain documentation to support your claim. Even if you’ve held the property for over a year before selling it, you should be prepared to demonstrate your intention and circumstances surrounding your purchase and sale.
During an audit, the CRA may request the following, where applicable:
- Agreements, such as the offer to purchase, contract of purchase and deed of sale
- Statement of adjustments prepared by the lawyer
- Mortgage contract
- Appraisals
- Subdivision plans where a large property is subdivided into smaller lots
- Zoning applications
- Listing agreements from the real estate agency
In addition to the above, you should retain documentation that may be useful in demonstrating your intention with respect to the property purchase. For example, keep a copy of the emails between you and your real estate agent that show your personal preferences during house hunting, such as school districts for your children if you plan to live in the home, or rental market data if you plan to invest in a rental property. If renovations were completed to suit your personal needs, such as installing safety rails for an elderly parent who lives with you, the contracts and invoices should be kept.
If you meet one of the exceptions to the flipped property rule, you should retain a record of the specific life event, such as details of an eligible work relocation where your new home is at least 40 km closer to your new work location.
What if a property is sold at a loss?
The flipped property rules only apply in the event of a gain on the disposition of residential real estate. However, if a residential property is sold at a loss and is claimed as a business loss against other income, the CRA will look to similar supporting information to determine if deducting the loss is appropriate. Note that the loss on the sale of personal property, such as a principal residence, is not deductible as a business loss or a capital loss.
How BDO can help
In light of the complexity and changes to tax legislation, combined with increased compliance efforts from the CRA focused on real estate dispositions, we recommend you reach out to a BDO tax advisor, especially if you’re being audited by the CRA.
The information in this publication is current as of February 12, 2024.
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.