Buying a home is usually the largest investment individuals will make in their lives. As such, it is extremely important that both buyers and sellers and builders are aware of the rules surrounding the collection and remitting of tax on real estate transactions, lest they be caught by the net cast by the CRA and are assessed penalties in addition to paying unremitted tax.
A recent announcement from the Minister of National Revenue spoke directly to this point.
On May 30, 2019, the Minister for National Revenue announced the updated results of the CRA’s audits in the real estate sector. According to the release, since 2015, CRA audits have identified over $1 billion in additional gross taxes, resulting in over $100 million in newly assessed penalties.
In 2018 alone, the CRA assessed over $171 million in additional gross taxes, a 65% increase from 2017, and rendered penalties over $57 million—more than double compared to the previous year.
The release explained that the 2019 federal budget will continue to support the CRA’s audit and enforcement goals, by granting $50 million over five years and an additional $10 million to create a ‘Real Estate Task Force’ that will focus on tax evasion in the Greater Toronto and Greater Vancouver areas.
The announcement comes after CRA’s move to work more closely with the provinces of Ontario and British Columbia to respond to an increase in tax risk in the real estate sector. According to the Minister, Diane Lebouthillier, these efforts will “combat non-compliance to better ensure tax rules in the real estate sector are followed by all Canadians”.
The announcement also made reference to a CRA backgrounder which further explained several identified risk factors which the agency uses to identify tax risk and possible tax cheats.
Notably, the CRA can track “correlations” between a taxpayer’s reported income and their lifestyle. For taxpayers underreporting their income, the acquisition of expensive assets, like a luxury home, without an obvious income source, can raise a red flag to the CRA of potential tax liabilities.
The CRA also identified confusion over the proper use of the principal residence exemption for tax-free sales of homes as an additional risk factor in the context of homebuilding/property flipping.
Where problems occur is when individuals engaged in these activities misapprehend the rules without seeking expert advice.
For example, many homebuilders/flippers incorrectly assume that selling the finished home will be tax-free if they live in it and fail to appreciate the conditions required to qualify for the principal residence exemption. Serial homebuilders/flippers may not eligible for the principal residence exemption because they may be found to be “carrying on a business”—being the renovation and sale of homes for profit. As such, their sales can be classified as business income, which is taxed at double the rate of capital gains—on top of not qualifying for the exemption!
Even if sale is treated as a capital gain, the homebuilder/flipper must declare a capital gain for the years in which it was owned but was not their principal residence. Failing to report this income can result in steep fines and penalties.
The CRA’s proposed Real Estate Task Force is designed to enforce compliance in this area. This follows the 2016 changes to the principal residence exemption which now requires all taxpayers to report details of the sale on their tax return to claim the exemption.
The takeaway from here is that both homebuilders and property flippers should tread with caution and consult experienced tax professionals to ensure that their real estate transactions are compliant with the law. In the end, these groups should be extremely cautious of making uninformed assumptions about when and where real estate transactions are subject to taxes or are eligible for exemptions.
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