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Introduction – Tackling the Affordable Housing Crisis

On April 7th, 2022, the federal government announced its new fiscal budget proposal. Many of the proposed changes were directed towards addressing the lack of affordable housing. One of these proposed rule changes specifically addressed the taxation of house flipping, and will be discussed in greater detail below.

Current Taxation Rules on House Flipping

When a taxpayer sells a property, the taxpayer must report the resulting income or loss. The income or loss from the sale of property can qualify as either business income or capital gains for the purposes of computing taxes. Business income and capital gains receive different tax treatment under the Income Tax Act. Business income is fully taxable. Business losses are deductible against non-capital (business) income. Those losses earned after 2005 can be carried forward 20 years and back three years (i.e., a business loss earned in 2021 can offset income earned between 2018 and 2041). Taxpayers may additionally be able to claim certain business expenses to decrease their business income. Conversely, only 50 percent of capital gains and losses are taxable or deductible, respectively. Capital losses can only be deducted from capital gains. Capital losses can be carried forward indefinitely and back three years. In certain circumstances the lifetime capital gains exemption can be applied to reduce capital gains. In almost all situations the capital gains results in less tax payable than business income.

A house which is sold on account of business income cannot qualify for the principal residence exemption. The principal residence exemption excludes from taxation all or substantially all of the taxable gain resulting from the sale of a home the taxpayer, or a related individual, ordinarily occupies. The amount the taxpayer can write off is calculated according to a prescribed formula.

The Income Tax Act does not have a bright-line rule for determining whether income is from business or capital gains. Instead, the courts have identified a number of factors which may be considered. These factors include:

  • The profession of the taxpayer
  • the length of time the taxpayer owned the property
  • The frequency and number of real estate sales the taxpayer has conducted
  • if any money borrowed for the purchase of the property

The factors are directed towards determining the intention of taxpayer, which is the central consideration in the classification of disposition transactions. Effectively taxpayers engaging in house flipping as a business should be claiming business income on the sale of their units.

The Proposed Change to the Rules on House Flipping

The Federal Budget issued April 7, 2022 proposes that all profits from the sale of residential properties held for less than 12 months would be considered business income. This rule would apply to all properties sold on or after January 1, 2023. Exceptions would be provided for certain enumerated circumstances such as death, disability and divorce. The government is currently accepting feedback and proposals on the list of applicable exemptions.

Points to Look Out For As the Tax Legislation Develops

No draft legislation has been released yet for this rule change. Canadian tax lawyers, tax accountants and impacted taxpayers will be interested in seeing how the government deals with some of the following points.

The Exemption List

The federal government has indicated the 12-month rule described above will have a list of exemptions based on certain life circumstances such as divorce which may cause a person to sell a property he or she did not otherwise intend to sell.  This mirrors one current consideration in deciding whether a person sold a property on account of capital or business which is the reason for the sale of the property. For example, a person selling a home to move closer to an ill relative will weigh in favor of a capital treatment of his or her profit on the sale of the home.

The federal government will need to “thread the needle” here between not making a list of exceptions which is so permissive that it undermines their intention to ensure that house flippers are paying their fair share of taxes, but is not so restrictive that it inadvertently catches taxpayers who are not engaging in house flipping.

Experienced Canadian income tax lawyers may use tax remissions applications to assist clients who are caught up by the 12-month rule, do not meet the list of exceptions but are not house flippers. A remission application is effectively a request to be exempted from a taxation rule wherein it is argued that applying the taxation rule to the applicant and his or her circumstances was not within the purpose of the legislation. Tax remission applications are generally considered a last resort as they are not often successful.

Timing

The federal government has stated the 12-month rule will apply to those who “held” a property for less than 12 months. What is unclear is how the federal government will define “held”. Likely, this will be from the close of the sale to purchase the property to the close of the sale to sell the property. Instead of freeing up more properties for purchase, this may lead to house flippers holding properties in their “inventory” for longer periods or push out the closing date on the sale.

Many house flippers will renovate, or even completely rebuild a home, before selling it. These renovations can take a substantial amount of time – especially if the renovation gets caught up behind permit approvals or construction issues. Inspire Homes, for example, estimates three to four months for a kitchen remodel from the design process to the end of construction. The sale of a property can also take several months, with the close of the sale happening weeks to months after the signing of the purchase and sale contract. House Prosperity estimates the average house flipper spends four to six months on a single property though, which would fall within the time period to be potentially caught by this new rule.

Pro Tax Tips – Tax Planning Around the Budget Proposals

Tax planning around budget proposals is a complicated task. The budget proposals are not themselves law, merely an indication of the direction the federal government intends to take. Not every budget proposal is accompanied by draft legislation. Draft legislation provides a better idea of the actual rules the federal government is putting in place. Lastly, new legislation has not yet been interpreted by the courts whose interpretations may impact the way the new legislation is applied.

At the same time, simply waiting for the law to develop can cause taxpayers to miss out on important tax planning opportunities and end up paying more in taxes. Early stances on new legislation can also impact the courts’ interpretation of the legislation to the benefit of taxpayers.

Taxpayers who may be impacted by the new budget proposals should contact our expert Canadian tax lawyers to understand the changes and tax plan around them.

F.A.Q.

What are the four possible tax treatments of a house sale?

A property can be reported as:

  • A principal residence for the entire period of ownership
  • A principal residence for part of the period of ownership, and a capital gain or loss
  • A capital gain or loss
  • Business income

What is the proposed new rule for house flips in the 2022 Budget?

The Federal Budget issued April 7, 2022 proposes that all profits from the sale of residential properties held for less than 12 months would be considered business income. This rule would apply to all properties sold on or after January 1, 2023. Exceptions would be provided for certain enumerated circumstances such as death, disability and divorce. The government is currently accepting feedback and proposals on the list of applicable exemptions.

Disclaimer:

"This article provides information of a general nature only. It is only current at the posting date. It is not updated and it may no longer be current. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in the articles. If you have specific legal questions you should consult a lawyer."

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