How real estate deals could trigger serious tax liabilities
Investing in real estate can be a smart move for many entrepreneurs.
Over the past decade or more, strategic real estate purchases—particularly on the residential front—have delivered returns on investment that, in some cases, have far exceeded those offered by equities and virtually all fixed-income savings vehicles. In hot markets such as Vancouver, Toronto—and until recently—Calgary, buying property in the right neighbourhood has delivered consistent financial home runs.
But many property owners have learned a very costly lesson in tax law when the time has come to sell those assets. That’s because the Canada Revenue Agency (CRA) is cracking down on residential property buyers who claim a real estate purchase as a primary residence, or in other cases as a rental property, but who actually intended to flip the property at the most opportune time to maximize their investment. What these purchasers are learning is that just such a sale could trigger a fully taxed income gain, and a steep tax bill.
Perhaps more troubling, CRA is currently in the midst of a blitz, analyzing specific real estate transactions over the past years for signs of improper tax reporting. The agency is focusing specifically on individuals who have sold multiple properties during that period. Although we can’t be sure where the CRA is obtaining sale information, we believe Ottawa might be acquiring data from builder or land registry records, in addition to annual tax returns.
While a stiff bill from the tax man is enough of a headache for entrepreneurs who often can’t withstand unexpected financial shocks, there are other risks that could be far more painful to their pocket book—and even their good standing in the community. If the CRA deems a vendor negligent in his reporting or non-reporting in his annual tax return, the agency could impose various penalties—from penalties of up to 50 per cent of the additional tax arising from the sale of the property, to 25 per cent of the GST owed on the sale of the property. That could extend to fines and jail time if the intent behind the misreporting is deemed to be criminal.
Not sure how to know when a property purchase is an investment? As you might already know, a gain incurred through the sale of a principal residence is generally tax free. That is, assuming you’ve actually lived in the property during the years you owned it. If you purchased a property with the intention of renting it, then sell that property, half of the increase in the value is taxable at applicable rates (which maximizes at roughly 25 per cent of the gain). Alternatively, if you purchase a property and intend to trade it without residing at the property or renting it to a tenant, 100 per cent of the increase in value is taxable as business income.
When conducting their investigations, CRA officials are sending questionnaires to property sellers to determine how long they owned the property (or properties) in question, when they moved in (if ever), the reason for their purchase, etc. Those who provide unsatisfactory answers—and who are found to have acted in contravention of the Income Tax Act, or who reported income erroneously—face the harsh penalties outlined above.
The lesson here is to think proactively and strategically when making any real estate investment.
Be sure to contact a chartered accountant for investment advice before making any such purchase. Then, if CRA does question your sale of the property, be sure to seek your accountant’s help in managing all communications with the agency. Properly explaining your situation and providing proper documentation can mean the difference between a hefty tax bill (or worse), or retaining your hard-earned cash.
Harris Kligman, Partner