Income Tax Traps from Flipping Houses or Condos

In recent years, a flood of individuals including real estate agents, professional contractors, and investors were buying and reselling homes in short periods of time for profit, commonly known as “property flipping”. Flipping also includes buying and selling condos before occupancy or closing – called an “assignment sale”. Quite often the seller would report the profits as capital gain (or exempt from tax as their principal residence) and not realize that there could be potential tax liability for full income inclusion, as well as GST/HST liabilities.

Tax obligations to be considered for these type of property transactions:

  • The taxpayers are required to report the profits from property flipping;
  • The profits from flipping real estate are generally considered to be fully taxable as business income;
  • The principal residence exemption is not available for property flipping;
  • The sale of the property may also be subject to GST/HST, which the seller would be responsible to remit to the CRA; and
  • A non-compliance reports could result in a penalty equal to 50% of the additional tax payable if a taxpayer knowingly makes a false statement when filing a return.

Cash flow considerations

The amount of cash flow that can be generated from the sale and its ability to compound returns are also very important for real property investment. Illustrated below is a simple analysis to show that for $200,000 profit, it could result in various levels of taxes (GST/HST is not included in this calculation), not only from the different nature of income but also whether the property is owned by an individual or by a corporation.

CRA Audit Activities

The CRA has been actively assessing taxpayers for non-compliance in real estate transactions and challenging taxpayers’ reporting treatment, either as exempt from income tax because of principal residence OR treated as capital gain. CRA disclosed the results of audit activities related to the real estate transactions in Ontario between April 2015 to September 2016: They completed over 13,403 cases and recovered over $210 million from the tax audits. Over $143 million was related to GST rebate and $42 million related to GST, and about $24 million was related to income tax. In addition, the CRA applied 663 penalties, totalling $12.5 million during this period.   

 

This article is intended for general information purposes only and does not constitute professional advice.  Income tax law and regulation change frequently and the content on this article may no longer reflect the current state of the law. If you have any specific questions, you should consult a professional services advisor or email us for further advice.