Anyone selling real estate during the year has to report such sales on their tax returns, even if any gain is 100-per-cent tax-free due to the principal residence exemption. Yet it appears Canadians still run afoul of the law when it comes to the appropriate tax reporting of those sales.
In a release last week, the Canada Revenue Agency provided an update on its ongoing project to 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 Toronto markets. In response to these risks, the CRA is continuing to take concrete action to crack down on those who fail to follow the law."
During the past three years, CRA auditors have reviewed more than 30,000 files in Ontario and British Columbia and identified nearly $600 million in additional taxes related to the real estate sector, which resulted in over $43 million in penalties. In 2017-2018, the CRA assessed $103 million 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 a condo 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 developers and builders, requesting information about the buyers involved in such sales. This information is then used by the CRA to identify taxpayers who may not be correctly reporting for both income tax and GST/HST purposes.
The CRA is also examining property flipping, which it goes out of its way to point out "is not illegal ... Canadians have the right to purchase and sell property for a profit." But the agency cautions that income resulting from these transactions is considered business income and must be reported as such to the CRA. Failure to do so can result in a reassessment of tax owing, with non-deductible arrears interest to boot. Even worse, you could also find yourself facing a gross negligence 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 being constructed in Toronto. In 2006, the taxpayer, who was also a real estate agent, entered into a contract to buy Unit 6 of the project while her granddaughter bought Unit 5. Both purchases closed 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 their 2010 tax returns. The CRA reassessed the taxpayer's 2010 tax year on the basis that she had failed 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 business income to her return, representing the gain on the sale of Unit 5. The CRA then charged them both with gross negligence penalties.
In court, the taxpayer and her granddaughter took the position that the profits on the sales of the condos should only be half-taxable as capital gains since they maintained it was their original intent to hold the condos on a long-term basis. They explained the condos were next to Seneca College, which the granddaughter was planning to attend after graduating high school; she would 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 her granddaughter had the financial resources to complete the purchases. The taxpayer's credit rating 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 to bridge the time between the closing of the purchases and the subsequent sales. She then used the proceeds from the sale of Unit 5 to help close the purchase of Unit 6. It also turned out that Unit 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 to sell the condos at a profit," which is a polite way of saying flip. As a result, the judge found the gains on each condo were properly characterized by the CRA as business income and not as capital 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 to report them at all."
In court, the taxpayer claimed she was not aware she had to report that profit. The judge found this explanation incredulous, saying, "When she filed her 2010 tax return, she would have been a real estate agent for approximately 23 years. I do not believe that she was unaware that profits 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 is reasonable for a 21-year-old whose tax experience consists of reporting relatively small amounts 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 she needed to report income on her tax return."