The new residential property flipping rule, introduced in Budget 2022, is now law. This rule was included in Bill C-32, which received Royal Assent on December 15, 2022.
The new rule deems profits from a “flipped residential property” as business income to target individuals that misclassify these profits as a capital gain to avoid taxes. It’s important to understand this rule as the Canada Revenue Agency (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.
How are gains on residential property ordinarily treated for tax?
When an individual sells a residential property, depending on the situation, the gain is treated as fully taxable business income or as a capital gain, which is 50% taxable. 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 individual 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 individual’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 is 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; individuals cannot 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
However, an exclusion may be available where the property is disposed of due to a qualifying life event.
Although not included in Bill C-32, the Fall Economic Statement 2022 proposes to extend this rule to gains arising from assignment sales. Accordingly, individuals who hold the rights to a pre-construction residential property and sell those rights for a gain within 12 months would be deemed to have received business income for tax purposes. The 12-month holding period would reset once ownership of the property transfers to the individual.
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 40km 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.
What are the non-compliance penalties?
If a taxpayer does not 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 individual 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. For more information see our blog discussing this.
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 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 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.