If you sell real estate, expect the taxman to take a close lookIf you sell real estate, expect the taxman to take a close lookin continued CRA crackdown.
In three years, CRA auditors have reviewed more than 30,000 filesand identified nearly $600 million in additional taxes, resulting inover $43 million in penalties
Anyone selling real estate during the year has to report such sales on their tax returns, even ifany gain is 100-per-cent tax-free due to the principal residence exemption. Yet it appearsCanadians still run afoul of the law when it comes to the appropriate tax reporting of thosesales.
In a release last week, the Canada Revenue Agency provided an update on its ongoing projectto address “non-compliance in real estate transactions.” The CRA said there continues to be“tax compliance risks in the real estate sector, particularly in the Vancouver and Torontomarkets. In response to these risks, the CRA is continuing to take concrete action to crack downon those who fail to follow the law.”
During the past three years, CRA auditors have reviewed more than 30,000 files in Ontario andBritish Columbia and identified nearly $600 million in additional taxes related to the real estatesector, which resulted in over $43 million in penalties. In 2017-2018, the CRA assessed $103million more in additional taxes than the prior year and penalties increased by $19 million.
The CRA is particularly taking a close look at “pre-construction assignment sales,” whereby acondo is purchased from a developer and sold to another buyer before the unit is completed.The CRA has issued what’s known as “unnamed persons requirements” to property developersand builders, requesting information about the buyers involved in such sales. This information isthen used by the CRA to identify taxpayers who may not be correctly reporting for both incometax and GST/HST purposes.
The CRA is also examining property flipping, which it goes out of its way to point out “is notillegal … Canadians have the right to purchase and sell property for a profit.” But the agencycautions that income resulting from these transactions is considered business income and mustbe reported as such to the CRA. Failure to do so can result in a reassessment of tax owing, withnon-deductible arrears interest to boot. Even worse, you could also find yourself facing a grossnegligence penalty equal to 50 per cent of the tax you sought to avoid.
That’s exactly what happened recently in Tax Court in a case involving a taxpayer and her then-17-year-old granddaughter, who each signed contracts to acquire condos in a building beingconstructed in Toronto. In 2006, the taxpayer, who was also a real estate agent, entered into acontract to buy Unit 6 of the project while her granddaughter bought Unit 5. Both purchasesclosed in June 2010. Unit 5 was sold that same month and Unit 6 was sold a month later.
Neither the taxpayer nor her granddaughter reported any income relating to the condos on their2010 tax returns. The CRA reassessed the taxpayer’s 2010 tax year on the basis that she hadfailed to report business income of $103,206, that total being the gain on the sale of Unit 6.Similarly, the CRA reassessed the granddaughter’s 2010 tax year, adding $106,025 of businessincome to her return, representing the gain on the sale of Unit 5. The CRA then charged themboth with gross negligence penalties.
In court, the taxpayer and her granddaughter took the position that the profits on the sales of thecondos should only be half-taxable as capital gains since they maintained it was their originalintent to hold the condos on a long-term basis. They explained the condos were next to SenecaCollege, which the granddaughter was planning to attend after graduating high school; shewould live in her condo while the taxpayer would rent her own condo out to third parties.
The judge was not persuaded by this explanation. As it turns out, neither the taxpayer nor hergranddaughter had the financial resources to complete the purchases. The taxpayer’s creditrating was too poor for any conventional lender and her granddaughter was earning less than$7,000 annually. The taxpayer had to borrow money from friends on short-term loans just tobridge the time between the closing of the purchases and the subsequent sales. She then usedthe proceeds from the sale of Unit 5 to help close the purchase of Unit 6. It also turned out thatUnit 6 was listed for sale before the taxpayer even took ownership of it.
Based on this, the judge concluded that the taxpayer’s “primary intention was always to try tosell the condos at a profit,” which is a polite way of saying flip. As a result, the judge found thegains on each condo were properly characterized by the CRA as business income and not ascapital gains eligible to be taxed at 50 per cent.
The judge also noted the CRA assessed harsh gross negligence penalties “not because the(taxpayers) failed to report their profits on income account, but rather because they failed toreport them at all.”
In court, the taxpayer claimed she was not aware she had to report that profit. The judge foundthis explanation incredulous, saying, “When she filed her 2010 tax return, she would have beena real estate agent for approximately 23 years. I do not believe that she was unaware thatprofits made selling real estate that is not one’s principal residence are taxable.” The judge,therefore, concluded the taxpayer was grossly negligent in not reporting her profit from selling Unit 6.
By contrast, the judge found that her granddaughter was not grossly negligent: “I think it isreasonable for a 21-year-old whose tax experience consists of reporting relatively smallamounts of T4 income on her tax return each year to rely on her own father and grandmother,both of whom are real estate agents intimately familiar with the details of a sale, to tell her if sheneeded to report income on her tax return.”