Tax Considerations of Flipping Houses
Some people believe that buying, renovating and selling houses is a great way to supplement their income. This is especially true if they can claim the house as their principal residence which allows any capital gain on the property to be exempt from taxation by Canada Revenue.
This practice of flipping property received less scrutiny from the taxman in decades past. Now both the taxing authority and the courts will take a look at a number of factors to decide how the money gained should be taxed. According to one opinion heard recently, Canada Revenue has increased the number of audits to catch this type of transaction and is also increasing the number of cases where the income is found to be business income rather than capital increase.
First and foremost, for a property to qualify as a principal residence, it must be lived in. It is insufficient to use the property as simply a mailing address while you renovate it. Next, the court will evaluate a number of criteria to determine whether the property is capital property, the profit from which is taxed as a capital gain, or business inventory, where the profit is taxed as business income at a higher rate. The criteria are:
The nature of the property sold;
The length of time the taxpayer was in possession as owner of the property;
The frequency and number of operations carried out by the taxpayer;
The improvements made by the taxpayer to the property;
The circumstances surrounding the sale of the property; and
The taxpayer’s intention at the time the property was acquired, as indicated by the taxpayer’s actions.
In addition to these criteria, Canadian courts have developed the "secondary intention" criterion that may apply even when the taxpayer's main intention has been established as making a long-term investment. This criterion applies if, at the time the property was acquired, the taxpayer had considered the possibility of selling the property for a profit if the long-term investment project could not be achieved for whatever reason.
You will notice that the "secondary intention" gives the court a lot of wiggle room to make factual findings against the taxpayer. Be cautious of this. It makes the analysis very factually dependent.
A recent case, Constantin v The Queen, 2014 TCC 327, illustrates the application. Nathalie Constantin purchased six properties over a three year period, holding five of them less than a year and the sixth, less than a year and a half. She was taxed on the basis that the properties were business inventory and that she realized business income from them when she sold them. She argued that they were a capital investment as she had originally intended to obtain rental income from them as part of a diversified retirement portfolio.
The court rejected Ms. Constantin's assertion that the houses were a long-term investment strategy and ruled that she owed takes on the profits as business income.
The Lesson: Carefully assess the criteria that will be evaluated by both the taxing authority and the courts and structure your transaction so that you can maximize the tax advantages.
Constantin v The Queen, 2014 TCC 327 http://www.canlii.org/en/ca/tcc/doc/2014/2014tcc327/2014tcc327.html?
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