(From the October 2022 Edition of eFORUM)
By Jamie Golombek and Debbie Pearl-Weinberg
The federal government is cracking down on certain individuals who are engaged in flipping residential real estate and not properly reporting these sales as business income. Flipping has been defined in government documents as “purchasing real estate with the intention of reselling the property in a short period of time to realize a profit.” On August 9, 2022, draft legislation was introduced setting out the government’s new anti-flipping rules to take effect in 2023. This proposal was first set out in the Liberal Party’s 2021 pre-election platform, with the goal being to “reduce speculative demand in the market place and help to cool excessive price growth.”
Let’s review the current income tax rules governing the sale of residential real estate, and the detailed new rules released in August.
The Principal Residence Exemption
Where a home qualifies as a principal residence, then the entire capital gain realized on its disposition can be realized tax-free by claiming the principal residence exemption (PRE). Numerous requirements must be satisfied before a claim can be made for the PRE, such as actually owning the home, and it ordinarily being inhabited for at least part of the year by the individual (or their spouse, common-law partner, or child.) If, however, the main reason for owning a housing unit is to gain or produce income, as would be the case for a rental property, then this criterion will not be satisfied.
Further, the gain realized on the sale must first be a capital gain, as opposed to business income, for the PRE to be available. In its publication on the Principal Residence  the Canada Revenue Agency (CRA) notes that the sale of a single house could result in business income, and the seller need not have any involvement in the housing construction industry for this to occur. In making the determination on whether a gain from the sale of real estate results in business income, factors historically considered by courts include the intention at the time of purchase, the length of time a property is held, and factors that motivated the sale.
The CRA has already been cracking down on perceived abuse of the PRE. Beginning in January 2022, letters were sent to individuals who claimed the PRE potentially “in error” in two scenarios. In the first scenario, the PRE was claimed by the individual for two years in a row, and CRA explained that where a property was purchased with the intent of selling it, the gain is taxable, and may be considered 100% taxable as business income. In the second scenario, the individuals had previously reported gross rental income. It was suggested in the letters that the taxpayers review their circumstances, and amend returns where necessary.
The New Anti-Flipping Tax
Under the proposed new rules, where there has been a disposition of a “flipped property,” any gain realized is taxable as business income and not as a capital gain. As such, the PRE will not be available, and the entire gain is taxable as 100% business income. A flipped property is defined as a housing unit in Canada that was owned for less than 365 consecutive days prior to its disposition. Exceptions to the definition exist for a number of life events including the death of the individual or a related party, an addition to a household, breakdown of a relationship, a threat to personal safely, serious illness or disability, work relocation or termination, insolvency or destruction or expropriation of the home. The anti-flipping rules will apply to dispositions of homes after 2022.
The proposed rules effectively set out a bright line test for a gain being ineligible for the PRE and 100% of the gain included in income, without the taxpayer’s intention being relevant. That being said, taxpayers who hold properties longer than 12 months with the intention of not satisfying the strict definition of a “flipped property” when selling could still find themselves the subject of a CRA audit based on the current rules, which disallow capital gain (and PRE) treatment if the intention was to flip the home.
Jamie Golombek, CPA, CA, CFP, CLU, TEP, is managing director, tax and estate planning with CIBC Private Wealth Management in Toronto. He can be reached at email@example.com. Debbie Pearl-Weinberg, LLB, is executive director, tax and estate planning with CIBC Private Wealth Management in Toronto. She can be reached at firstname.lastname@example.org.