This 2023, in the desire to generate more income, the federal government is also cracking down certain individuals engaged in flipping residential real estate and improperly reporting the sales as business income.
Principal Residence Exemption
When a home qualifies as a principal residence, the income from the sale of such home may be exempt from capital gains under the principal residence exemption (PRE). To be eligible for PRE, there are many factors such as but not limited to actually owning the home, and inhabiting the home for at least part of the year by the individual (or spouse, common-law partner or child).
An example would be if A bought a property for $500,000 and sold it for $650,000 after 5 years of living in it, the income of $150,000 from the sale would be tax-free under the PRE.
Capital Gains for Sale of Rental Property
Notably, if the main reason from owning a housing unit is to gain or produce income, such as in the case of a rental property, then such home will not be eligible for the PRE. The income realized on the sale of a rental property would be taxed as capital gains. The income taxable is only 50% of the gain.
So if A bought a property for $500,000 and had it rented out and afterwards sold for $650,000 after 5 years, the income to be considered as gain is only $75,000.
Business Income for Sale of Flipped Property
The income from the sale from flipping, assignment or buying to build and sell the property is generally taxed as business income at the seller’s tax rate.
So if A bought the property for $500,000 and made renovations to it amounting to $100,000 and sold the same to B for $750,000, the income of $150,000 would be taxed as full business income. CRA would then look at A’s tax rate and apply the rate against the $150,000 income.
The New Anti-Flipping Rule
The CRA has found that house flippers have been incorrectly using the PRE to avoid or minimize taxes. Under the new Rule, the gain in the disposition of “flipped properties” are to be realized as taxable business income and not as capital gain.
The Rule provides that an individual who sells a residence within 12 months of acquiring it will be deemed to have flipped it unless they fall under any of the exceptions. The exceptions include a number of life events including the death of the individual or a related party, an addition to a household, breakdown of a relationship, a threat to personal safety, serious illness or disability, work relocation or termination, insolvency or destruction or expropriation of the home.
This new Rule would take effect for transactions occurring on and after January 1, 2023. We highly advise that you approach your accountant or your tax lawyer if you are intending to sell any property within 12 months from your date of purchase to avoid being considered under this Rule.