Understanding the Tax Implications of House Flipping in Canada
House flipping has become a popular way for many Canadians to invest in real estate. The concept is simple: buy a residential property, renovate it, and sell it for a profit. Whether you are an individual investor or a professional renovator, the appeal of turning a quick profit can be very tempting.
While the process can seem like a relatively simple way to achieve a profit, the tax implications of house flipping are often overlooked or misunderstood. The CRA has strict regulations regarding how income from house flipping is taxed. It is crucial to understand that non-compliance with these regulations can lead to significant financial and legal consequences.
What is House Flipping
At its core, house flipping involves purchasing a property, making improvements, and then reselling it. The goal is to increase the property’s value enough to make a profit after accounting for purchase costs, renovation expenses, and other fees.
Capital Gains vs Business Income
One of the most common misconceptions is that profits from house flipping are treated as capital gains. While capital gains enjoy the preferential treatment of having only 50% of the profit included in taxable income, this benefit is typically reserved for long-term investments where the intent was to hold the property.
In most house flipping scenarios, on the other hand, the CRA does not consider the activity to be a passive investment. Instead, profits earned from flipping are typically classified as business income. Unlike capital gains, this business income is fully taxable and 100% of the profit must be reported and subjected to income tax at your marginal tax rate.
The distinction between capital gains and business income depends on the taxpayer’s intention at the time of purchasing a property and their behaviour during ownership. If a property is purchased with the intention to renovate and resell it for a profit, the CRA may treat it as a business operation. Other factors that influence this determination include the:
- Frequency of Similar property transactions;
- Duration of ownership;
- Circumstances related to the sale of the property;
- Extent of renovations; and,
- Nature of the Property
Principal Residence Exemption
Another area of concern is Canada’s Principal Residence Exemption (the “PRE”). This exemption is a tax benefit that allows homeowners to sell their primary residence without paying capital gains tax.
While some individuals may attempt to claim this exemption when flipping houses by briefly occupying the property or claiming it as a residence without the genuine intention to live there long-term, CRA actively monitors and audits these claims. If the CRA determines that the PRE was claimed inappropriately, it can disallow the exemption and reassess the profit from the sale as business income. This can result in a much higher tax liability and potential penalties for misreporting.
The New Residential Property Flipping Rule
Starting January 1, 2023, there are rule specifically target flipped properties. If you sell a residential property within 365 days of purchase, the gain is deemed to be business income and is fully taxable. This rule applies even if the property is not part of your inventory and includes assignment sales where you sell the rights to purchase a property within 12 months.
This rule eliminates the ability to claim the principal residence exemption on flipped properties and prevents reporting a business loss from such sales. Exceptions exist for qualifying life events such as death, marriage breakdown, or involuntary job loss, but these are narrowly defined.
Reporting Requirements
All income derived from flipping must be accurately reported on the taxpayer’s income tax returns. Failure to report this income appropriately, mischaracterizing it as capital gains, or improperly claiming the principal residence exemption, can result in penalties, reassessments, and interest charges.
Given the complexity and legal implications of the tax rules governing house flipping in Canada, individuals considering such ventures may benefit from seeking professional advice before undertaking a project.
***Disclaimer: This article provides information of a general nature only. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in this article. If you have specific legal questions, you should consult a lawyer.
Connor Tzountzouris