With the red-hot residential real estate markets of Toronto and Vancouver showing no signs of cooling down, taxpayers need to be aware that the Canada Revenue Agency is paying even closer attention to tax compliance in this sector. While transactions in the Greater Toronto Area have so far been the subject of greater scrutiny, including audits, the CRA has recently been actively monitoring and auditing real estate transactions in British Columbia.
In the year ending March 31, 2016, the CRA audited about 1,864 Ontario real estate files and recovered nearly $18 million in income tax and $32 million of GST/HST. In B.C., audits of 339 files resulted in $4.2 million in recovered income tax and $10 million in recovered GST/HST. The CRA issued nearly $10 million of penalties in 447 of these cases, with the highest penalty being almost $2.5 million.
In a recent release, the CRA explained how it addresses non-compliance in the real estate sector using a combination of advanced risk-assessment tools, analytics, leads and third-party data to detect and address what is essentially tax evasion. The CRA then audits the files of taxpayers that it identifies as being high risk.
The CRA identified a number of areas of compliance risk in the real estate sector, including:
Questionable source of funds
The first concern identified by the CRA is taxpayers who buy a property with funds that may never have been taxed, whether in Canada or abroad. For example, a large down payment on a home may indicate that the purchaser has unreported income, either earned from legal or illegal sources. This is particularly an issue when the lifestyle of the buyer is incompatible with the income reported on their tax returns.
The second common area of concern is flipping, an activity by which some Canadians, including real estate agents, buy and resell homes in a short period for a profit. These could be professional contractors or renovators who rapidly buy and sell real estate for profit (sometimes demolishing or renovating the property), speculators or “shadow flippers.” This latter group are middle investors who buy a property and then, for a profit, assign the right-to-sell clause that is in the contract to another speculator or the final buyer. Flipping is also done by individual renovators who buy real estate, renovate it, and then live in it for a short time before selling so they can claim the principal residence exemption several times in their lifetimes.
While real estate flipping isn’t illegal, the money made on real estate flips, including any real estate commissions and appreciation in value, must be reported to the CRA.
In its report, the CRA stated that it acquires and analyzes third-party data and has found that some flips are either not being reported at all for tax purposes or are being reported incorrectly. The profits from flipping real estate are generally considered to be fully taxable as business income, as opposed to a capital gain (which is only half taxable).
Unreported GST/HST on the sale of a new or substantially renovated home
While the sale of used housing is generally exempt from GST/HST, the builder of a new or “substantially renovated home” must charge and collect GST/HST when the home is sold. The CRA says it uses “various analytical techniques to identify builders who are not complying.”
Unreported capital gains on the sale of property
If you sell your home at a profit, in most cases you won’t have to pay any capital gains tax because of the principal residence exemption. If the home doesn’t qualify as a principal residence — a rental property or cottage, for example — then selling the property for proceeds greater than its cost generally results in a capital gain, half of which is taxable at your marginal tax rate.
If the owner of the Canadian real estate is a non-resident, then she is required to pay Canadian income tax on any profit and would generally not be eligible for the principal residence exemption. The tax rules require non-residents who sell Canadian property to notify the CRA within 10 days and to pay an amount to cover their estimated Canadian tax liability.
In its release, the CRA encouraged taxpayers who have engaged in real estate transactions and have either not reported them or “have not correctly reported them” to go online to correct their prior years’ tax returns. The CRA also reminds us that if you suspect that someone you know may not have reported income or paid GST/HST on a real estate (or any other) transaction, you can tip them off, anonymously, via the CRA’s National Leads Centre.