Flipping houses? Expect to face tax on 100% of your profits
News reports of insider trading and house flipping among some Metro Vancouver real estate agents has led B.C.’s Superintendent of Real Estate, Carolyn Rogers, to launch an investigation into the matter.
Earlier this week, NDP housing critic David Eby claimed that some B.C. real estate agents have been avoiding property transfer tax as well as capital gains taxes by using a clause in real estate contracts that allows homes to be flipped.
But when it comes to house flipping, Canadians need to be warned that profits from real estate may not necessarily be taxed as a capital gain, in which case only 50 per cent is taxable, but rather they could be taxed as business income, in which case 100 per cent of the profit is subject to tax.
The most recent published tax case on flipping real estate occurred just over a year ago when a taxpayer found herself in Tax Court fighting CRA reassessments for multiple years in which she disposed of six real estate properties and realized total profits of more than $100,000. While she reported them as 50 per cent taxable capital gains, the CRA said the transactions should be treated as business income and thus fully taxable. The average holding period of five of these properties was nine months and the taxpayer financed her properties via a one-year mortgage.
The taxpayer’s argument was that she wanted to keep the real estate “in order to generate rental income and extra income during retirement.” As it turned out, however, she reported significant rental losses in two of the tax years and she didn’t keep any of her properties for the long term. The taxpayer explained that the reason she sold the real estate within such a short time frame was that “rents were too low.” This argument wasn’t convincing enough for the CRA, which maintained that the taxpayer “has a lot of experience and could not have been unaware that the price of income properties is determined on the basis of rents.”
While the Tax Act doesn’t list the criteria to distinguish when profits are taxed as business income rather than a capital gain, the case law has developed a number of factors that are generally taken into account in making this determination. These factors include: the nature of the property sold, the length of time you owned the property, the frequency and number of real estate transactions you carry out, the improvements you made to the property (if any), the circumstances surrounding the eventual sale of the property as well as your intention at the time the property was acquired.
The judge, upon reviewing these criteria, concluded that the taxpayer acquired the properties for the purpose of reselling them at a profit “at the earliest opportunity,” rather than holding them as long-term investments with the intention “to build a diversified retirement portfolio,” and that the taxpayer’s main intention was to make short-term investment returns. As a result, the taxpayer had to pay tax on the profits as business income, not as half-taxable capital gains.
Using the criteria above, it’s likely that any profits enjoyed by those Vancouver real estate agents would be fully taxable as business income, especially since their intention was to profit from a quick flip. Although perhaps their bigger intention was to avoid getting caught in the first place.