The residential property flipping rule deems profits from a "flipped residential property" as business income to target taxpayers that misclassify these profits as a capital gain to avoid taxes. It’s important to understand this rule as the CRA has increased the number of audits relating to these types of transactions, which can lead to hefty penalties and interest for non-compliance.
The new rule applies to flipped residential property dispositions that occur on or after January 1, 2023. This rule, introduced in Budget 2022, was included in Bill C-32, which received Royal Assent on December 15, 2022.
How are gains on residential property ordinarily treated for tax?
When a taxpayer sells a residential property, depending on the situation, the gain is treated as fully taxable business income or as a capital gain, which is taxed more favourably. For individuals and certain personal trusts, if the property qualifies as a principal residence the gain may be reduced or eliminated by claiming the principal residence exemption.
Aside from the new residential property flipping rules, there’s no other rule to determine whether the gain on the sale of a residential property should be treated as business income or a capital gain, under the Income Tax Act. Instead, it’s a question of fact, and the courts have considered the following factors when deciding this issue:
- The taxpayer’s intention regarding the property at the time of purchase
- The nature of the business, profession, calling, or trade of the taxpayer and their associates
- The extent to which borrowed money was used to finance the acquisition and the financing terms arranged
- The length of time the real estate was held
- The factors motivating the sale.
Note that this list isn’t exhaustive, and any of the factors by itself isn’t conclusive. However, the closer the taxpayer’s business or occupation is related to real estate transactions, the more likely the gain on a sale would be considered business income by the CRA.
What's the residential property flipping rule?
Under the new rule, a gain on a “flipped property” sale is deemed to be business income and fully taxable. No principal residence exemption is available to reduce the tax. This rule only applies to gains; taxpayers can't report a business loss on a property just because it meets the definition of a flipped property.
A “flipped property” is defined as a housing unit that:
- Is located in Canada
- Would not otherwise be inventory of the taxpayer
- Was owned by the taxpayer for less than 365 consecutive days prior to the disposition of the property.
The definition of “flipped property” includes the right to acquire a housing unit. This extends the residential property flipping rule to gains arising from assignment sales. Taxpayers who hold the rights to a pre-construction residential property and sell those rights for a gain within 12 months will be deemed to have received business income for tax purposes. The 12 month holding period resets once ownership of the property transfers to the taxpayer. The expanded definition included in Bill C-47 received Royal Assent on June 22, 2023. This rule applies retroactively to dispositions that occur on or after January 1, 2023.
An exclusion may be available where the property is disposed of due to a qualifying life event.
What are the exceptions?
Where it’s reasonable to consider the disposition occurred due to, or in anticipation of, one or more of the following events, the residential property flipping rule will not apply where there’s a:
- Death of the taxpayer or a related person
- Related person joining the household (birth of child, adoption, or care of elderly parent) or the taxpayer is joining a related person’s household
- Breakdown of marriage or common-law partnership of the taxpayer (if living apart for at least 90 days prior to the disposition)
- Threat to the personal safety of the taxpayer or a related person
- Disability or serious illness of the taxpayer or a related person
- "Eligible relocation" of the taxpayer or their spouse or common-law partner (e.g., a work relocation where the new home is at least 40 km closer to the new work location)
- Involuntary termination of employment of the taxpayer or the taxpayer’s spouse or common-law partner
- Insolvency of the taxpayer
- Destruction or expropriation of the property against the taxpayer’s will (e.g., due to a natural or human-made disaster).
However, even if one of the above exceptions applies, or if the property was held for 365 days or more, it remains a question of fact whether a gain on a residential property sale will be taxed as business income or a capital gain.
Draft legislation released on August 12, 2024, adds an exclusion for a deemed disposition by a trust due to the death of a beneficiary. This amendment adds to the existing exclusion for the death of the taxpayer or a related person.
What are the non-compliance penalties?
If a taxpayer doesn't report a gain on the sale of residential property as business income when required, they could be assessed a gross negligence penalty equal to 50% of the additional taxes owing, in addition to interest charges. Taxpayers who would like to report an omission of income or correct a previous error may qualify for penalty relief under the CRA’s Voluntary Disclosure Program. However, one of the criteria to qualify is that no CRA enforcement action has already begun.
Don’t forget potential GST/HST implications
A taxpayer who sells a property may be required to charge GST/HST on the sale, depending on the actual use of the property during the time between original purchase and sale. Further, if a taxpayer is considered a “builder” within the meaning of the Excise Tax Act (one example is where substantial renovations were done), the property may also be subject to GST/HST on the sale. Finally, as a result of changes made in Budget 2022, a sale made by an taxpayer of a residential
condominium or single unit residential complex by way of assignment is taxable for GST/HST, regardless of the reason for the acquisition of the property.
Takeaway
Under the new rule, where a residential property is bought and sold within a year, there will be an automatic assumption that it’s a flipped property and the profits will be fully taxable as business income, unless one of the above-noted exclusions apply. However, where the residential property flipping rule doesn’t apply to the disposition of a residential property, case law and the relevant facts would still need to be considered to determine the tax treatment.
The rule is complex, and we can help you determine whether it affects you—contact your local advisor or reach out to us here.
Disclaimer
The information contained herein is general in nature and is based on proposals that are subject to change. It is not, and should not be construed as, accounting, legal or tax advice or an opinion provided by Doane Grant Thornton LLP to the reader. This material may not be applicable to, or suitable for, specific circumstances or needs and may require consideration of other factors not described herein.
