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Is your property sale eligible for capital gains tax?

Frustrated young business man real estate loopholes capital gains tax

For a very long time, seasoned real estate investors and house-flippers paid only half the tax owed to the taxman.  But the CRA has cracked down on this practice.  So how can home sellers continue to avoid capital gains tax? Be sure to understand the rules before you sell your property.

The loophole that allowed home flippers to avoid all taxes owed (by just paying capital gains tax) was closed as of January 1, 2016.  The Federal Government announced on Oct. 3, 2016, that all property sold during and after the 2016 tax year must be reported to the Canada Revenue Agency (CRA).

Prior to this change, anyone who sold their principal residence didn’t have to report the sale. Now, all property sales must be reported.  However, the principal residence exemption remains in place.  This means you won’t owe capital gains tax on the profit earned from selling your primary home.

So, how does this impact property investors? First, it just got a whole lot harder to hide profit from the sale of a property. Second, CRA has started to scrutinize every property sale.  The idea is that not every property is taxed using the capital gains tax.

Advantages of capital gains tax

capital-gains-tax-Canada-Revenue-Agency

According to the CRA, profit on assets and investments are taxed in a variety of ways.  It could be taxed as a capital gain, interest, personal or business income, or as a dividend. Each tax has its own rules and its own rate.

Personal income is taxed heaviest, followed by interest and business income. Dividend and capital gains income are considered the most advantageous.  Both receive preferential tax treatment. When it comes to property, including assignment sales, capital gains tax is typically applied.  That is unless the CRA considers the profit earned on a property sale to be part of business income.

So, how does the CRA make this distinction? In Canada, if a property grows in value the appreciation is known as a capital gain. Capital gains are subject to only half-the-tax. This means the profit on a property sold in Canada is only charged half the marginal tax rate of the seller.

For example, if you sold your cottage (which is your secondary residence), you’d pay capital gains tax on the appreciation of that property, not income or business tax. If the profit was $100,000 you’d only owe tax on $50,000. If your marginal tax rate was around 30%, that would mean you only owe $15,000 in taxes on that profit.  But if you’d been charged personal or business income tax, you would’ve had to pay $30,000 (assuming the same marginal tax rate; more if this income pushed you into a new tax bracket).

For your property to qualify for the preferential capital gains tax rate, you must not be in the business of investing in real estate.

How business income relates to profit from property sales

Investment properties may not qualify for capital gains taxes when resold

What about real estate investors who purchase property with the intention of selling it for a profit? Can they shelter a portion of their profit by paying capital gains tax rather than income or business tax? According to Ottawa-Gatineau tax firm, Marcil Lavallée, some types of gains “fall close to the line.”

In the Income Tax Act, the definition of the term “business” includes “an adventure in the nature of trade.” According to the CRA, if a person or legal entity purchases property with the intention of selling it, then this purchase is considered to be an “adventure in the nature of trade.” Any profit earned on this property is not a capital gain, but rather business income and should be taxed accordingly.

The CRA started cracking down on real-estate investors over half a decade ago and the federal agency doesn’t intend to stop now.

In February 2016, CTVNews reported that the CRA was investigating the sale of 128 homes in B.C., to discover whether or not the sellers were sheltering their profits using capital gains tax. “The CRA told CTV News it’s concerned sellers may not be properly reporting house flips and paying the taxes they should.”

In July 2017, headlines proclaimed that the CRA was going after developers — looking for presale information to see if those trading in assignment sales were skipping out on all taxes owed.

In October 2017, there were more headlines about condo presales and the CRA casting a wider net to catch tax cheats.

What you need to know about capital gains

Purchase real estate capital gains tax implications

If you purchase real estate with the intent of selling it for profit, get professional tax advice.  Especially if the timeline of the purchase and intended sale is relatively short (a few years or less).

It’s also true if you are buying and selling pre-sale condos (sales known as assignment sales — assignments are contracts that give you the right to own or sell ownership rights to a property that is still in the process of being built).

Create a solid plan for how you intend to report the investment. Are you in the business of real estate investments? Or are you investing in real estate with the intention of earning a profit? Why is this important? Because you cannot mix apples and oranges.

Tax specialists will tell you, an investor cannot claim business expenses against a capital gain. Property expenses can only be used to reduce income earned on a property, such as rental income.  They cannot be used to reduce overall capital gain. Meaning, if you sell a condo the same year you are required to pay for a special assessment, you may only claim the cost of the assessment against the rental income earned.  You cannot use the expense to reduce the capital gain earned on the property.

To keep it simple, just remember: The only way to reduce or avoid a capital gain is a capital loss. A capital loss occurs when you sell an asset for a loss.

Have a plan when buying a property

take time to plan tax implications of real estate purchases

You should always know before you purchase a property what the short-term and long-term goal is for that property. Do you intend to be a landlord and create your own dividend-like income stream? Or is your intention to buy and sell based on market movements?

If you intend to become a landlord, your property purchase would be treated as a rental property investment.  Appreciation is secondary to the investment plan and the sale of the property would trigger capital gains owed.

If you intend to buy and sell quickly, appreciation is the sole motive for investing in the property.  As a result, you are engaging in the “adventure of trade.”  Your profit would be taxed as personal or business income.  You cannot shelter the profits by paying capital gains tax.

The CRA started cracking down on real estate investors a few years ago.  In the years to come, we can expect more audits and back-taxes paid by real estate investors.  So if you are on the wrong side of that capital gains tax, beware, the CRA is watching.

Updated: July 17, 2020

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Romana King

Romana King is an award-winning personal finance writer, real estate expert and the current Director of Content at Zolo. Romana has contributed to business and lifestyle publications including CBC.ca, Toronto Sun, Maclean’s, MoneySense, Globe & Mail Custom Content Team, and The Toronto Star. Among her achievements, Romana won silver for her annual Where to Buy Now real estate package in the 2019 Canadian Online Publishing Awards. In 2015, she won a SABEW Business Journalism award. When she was editor of CI Top Broker, Romana helped guide her team to obtain its first KRW Business Journalism nomination, and in 2011, she was part of a small team that helped MoneySense win Magazine of the Year at the 34th annual National Magazine Awards.