What you need to know about residential property flipping and your income taxes

Property flipping involves the purchase of real estate with the intention of reselling it for profit in a short period of time. The 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 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 capital gains treatment, 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 at a gain occurs within 365 days of its acquisition is also treated as business income. 

Where this rule applies, reasonable expenses that were incurred to earn the 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 rule that apply if the sale is due to certain life events such as death, marital breakdown, addition of family members, serious illness or disability, eligible work relocation, involuntary termination of employment, insolvency, threat to personal safety, or destruction or expropriation of the property.

The flipped property rule applies to corporations in the same manner as it does to individuals. The following are relevant to note for transactions affecting corporations: 

365-day holding period

A residential property held by a corporation and disposed of within 365 days after an amalgamation, wind-up, tax-deferred rollover, or transfer at fair market value may be subject to the flipped property rule. As the rules are currently written, there is no continuity of ownership for purposes of the flipped property rules that would accommodate these types of transfers to a corporation. This means that the 365-day holding period starts when the property is acquired by the disposing corporation. For example, in the case of an amalgamation, when two or more corporations merge to form a new corporation, the newly formed corporation is considered to have acquired the property at the time of amalgamation. If the residential property is then disposed of within 365 days, the flipped property rule would apply, and any gain would be taxable as business income and any loss would be denied.

Small business deduction (SBD)

Generally, the active business income of a Canadian-controlled private corporation (CCPC) qualifies for the SBD, which reduces the corporate tax rate. The CRA has stated that it is their opinion that income from the disposition of a flipped property could be considered income from an active business and qualify for the SBD, subject to the existing limits and requirements.

However, the CRA has also stated that, depending on the circumstances, where the main purpose of a transaction is to obtain an undue tax benefit that the taxpayer would not otherwise be entitled to, then the general anti-avoidance rule (GAAR) may apply.

Recent highlights of CRA’s additional guidance related to the property flipping rule are as follows:

Change in use

When there is a change in use of all or part of a real estate property, such as converting from a principal residence to a rental property, there is generally a deemed disposition and immediate reacquisition at fair market value under the Income Tax Act (ITA). The CRA has confirmed that this deemed disposition would not trigger the flipped property rule because the change in use does not change the taxpayer's ownership of the property. 

Beneficiaries of an estate

The CRA was asked whether a residential property received by a child beneficiary from their deceased parent’s estate and sold by the child within 365 days can be excluded from the flipped property rule on the basis that the disposition can reasonably be considered to have occurred due to the death of the taxpayer’s parent. As noted above, one of the life event exceptions to the flipped property rule relates to death of the taxpayer or a person related to the taxpayer.

In response, the CRA stated that it would be a question of fact whether this exception would apply, but where there is a sufficiently clear connection between the death of the parent and the disposition of the housing unit by the child beneficiary, then it would be possible that the flipped property rule would not apply.

Self-constructed homes

With respect to the construction, self-construction or replacement of a residential property, the CRA indicated that the holding period begins once the home becomes habitable. This is a question of fact and is usually considered to occur when the home has running water, electricity, heating, functional bathroom, etc.

In cases where the 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 the taxable portion of the gain would be subject to tax. 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.

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.

The CRA regularly conducts audits related to real estate transactions 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 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 or notary (as applicable)
• 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.

Note that while Quebec has amended its legislation to follow the federal flipped property rule, Revenu Québec conducts their own tax audits.

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.