If you listen to the radio or watch daytime television, you likely have heard and seen ads about house or condo flipping as a quick and easy way of making thousands of dollars. One method was pre-construction flipping. You find a residence or condo unit that is under construction, buy it, and then before it is built or shortly after construction is complete, sell it for a profit. Although this has been profitable for some flippers throughout Ontario, the process is not as simple as it appears. Further, the practice has come to the attention of the CRA (Canada Revenue Agency) who are investigating flippers, finding that many have not paid income on the capital gains. Consequently, the CRA has imposed substantial penalties on those who unlawfully evaded the tax.
Pre-construction flipping is also known as assignment sales, since you are contracting with the builder over property that does not yet exist. Although the builder is not required to disclose this transaction, the CRA is not prevented from developing or using software to track assignment sales.
Under the Income Tax Act, the CRA can demand that you disclose to it all details of any transaction. Lately, CRA officials have looked into condo sales to investigate assignment sales to uncover abuses. Once alerted by the CRA, you will have to disclose the date you purchased the condo, what you paid for it, the date of sale, and the sale price. If you sold the condo within 12-months of its purchase, your transaction will be scrutinized to see if you claimed the personal residence exemption on the gains you made. If you are being scrutinized or are thinking of buying a condo as part of a short-term investment strategy, talk to an experienced Toronto real estate lawyer from Affinity Law.
Also, when you sell a pre-construction condo contract, you are considered the builder, which means you will owe the government capital gains tax and HST. This applies not only to the profit you make when selling the contract, but to the deposit that is returned to you.
HST issues arise under the following circumstances:
- The HST is generally included in the purchase price of the condo. It is charged at the lower rate since builders assume the buyer will reside in the unit and qualify for the rebate. If the unit is sold, the builder may be reluctant to provide the rebate to the third party and will pay it to the CRA. The third party then has to claim it. If the builder absorbed the rebate for the buyer’s benefit but who never lived in the residence, the CRA will go after the builder.
- Assignors of an assignment sale have to pay the HST on the higher assignment price being charged. Any profit is subject to income tax.
- If the assignor is a non-resident of Canada, the new buyer must withhold whatever HST the assignor owes on the transaction or the CRA will come after the assignee.
You can try to get the assignee to pay the HST although that will certainly deter buyers. Or, like some have done, simply not add it to the sales price or designate themselves as investors rather than traders to evade the tax. However, the tax has to be paid by someone. As an investor, you would pay 50% on your capital gains. As a trader, it is 100% since it considered business income.
Informal Auditing by CRA
If you have been involved in a pre-construction condo transaction, the CRA may send you a questionnaire to complete regarding the transaction, which is similar to an audit. If you have received such a questionnaire, immediately contact a Toronto real estate lawyer since you risk substantial penalties as high as 50% of the tax debt you were assessed if you are found to have been grossly negligent. If you have been assessed, then you likely owe penalties. However, you do have 90-days to file a Notice of Objection to the penalties.
What is the Residential Tax Exemption?
To claim the residential tax exemption, you have to report the disposition and designate the property as your principal residence on Schedule 3, Capital Gains (or Losses) on your tax forms. The exemption allows you any profit gained from the sale as tax-free. You do have to show intent to live there, or that a job or life-changing event forced you to sell soon after its purchase. Intent can be shown by:
- Mail with your name and address on it
- Utility usage
- You recorded the address with Service Ontario
- Photos of you in the furnished unit
If you had to sell within a short time after its purchase, you can show intent by:
- Proof of recent financial difficulties
- New job that requires relocation
- A relationship ended that forced the sale
Consult with a skilled Toronto real estate lawyer at Affinity Law if your intent is being questioned by the CRA.
How to Prove It’s an Investment
An assignment sale is fraught with risks for those contemplating pre-construction condo flipping. If you are an individual who has done similar transactions in the past, be aware that the CRA may look at these factors in determining if your property qualifies as an investment or trade:
- Was ownership for less than one-year?
- What expertise or experience do you have relevant to real estate or taxation?
- Your history of prior transactions
- Were improvements made close to the sale?
It is far better to invest in such property for the long-term so as to avoid harsh tax penalties and to enjoy any gains you do receive if not only to avoid CRA scrutiny. Here are some suggestions if you are thinking of buying a condo as an investment for the short term:
- Hold it for at least one-year, though 18-24 months from date of possession is more credible
- Lease it out for at least one-year to be eligible for an HST rebate of up to $24,000
- When you do sell, you can deduct operating expenses from your profit and be only taxed 50% on capital gains
In any event, a short-term investment in real estate may not result in the quick profit promised by those radio and television ads. A Toronto real estate lawyer from Affinity Law can provide you the advice you need so you can make an informed decision about this and any other real estate investment.
Call us today for a free consultation at 1 844 786 LAW 1 (5291).