The real estate sector is a major area of attack for CRA auditors. Because the dollar amounts involved in real estate transactions are very large, the “profit” to the CRA on any file can be very substantial. Both income tax and GST/HST assessments can be extraordinarily expensive for the person assessed.
The CRA’s main areas of concern in real estate are the following:
Questionable source of funds
The source of funds used to buy or maintain Canadian properties could be an unreported source that was never taxed, either in Canada or another country. A large down payment on a home, or a property that is expensive to maintain, may be an indication of unreported income, tax evasion, or even a purchase by a low-income person hiding a wealthy buyer.
Buying a high-end home, without an obvious income source, is a flag to the CRA of potential unreported income earned from legal or illegal sources.
If someone buys a home or condo and then sells it soon after, the CRA considers that person to be “flipping”. If the intention on buying was to resell for a profit, the property is not “capital property” for income tax purposes. The profit is fully taxed as business income. The principal-residence exemption does not apply, even if the person moved into the home and lived there for a period of time.
The CRA sometimes gets this wrong. A buyer who buys a condominium pre-construction might not be able to close the purchase for several years due to construction delays. In the meantime, the buyer’s circumstances may have changed. Still, if you actually own the condo for less than a year after the closing, the CRA will generally assume you intended to sell it, and will reassess you on the basis that your gain on the condo was business profit. You might be able to convince the CRA or the Tax Court otherwise, but the process will be financially and emotionally draining.
Some taxpayers are clearly in the “business” of flipping homes. They buy and sell many properties, sometimes renovating, sometimes moving in for a while and then not reporting the gain because they think the principal-residence exemption applies.
The CRA goes after these taxpayers, and may assess them for income tax on their profit, GST or HST on the new home (including the land value), interest and substantial penalties. Of course, real estate records are easily available to the CRA, so the CRA can always find out who bought a property, when and for how much. And if the CRA believes that the taxpayer deliberately or negligently failed to report the income, there is no time limit for the CRA to reassess the taxpayer.
GST/HST on sale of a new (or substantially-renovated) home
If you build or “substantially renovate” (gut and redo) a home, then GST or HST applies when you sell the home. If instead of selling it you move in, or you rent it out, you have what’s called a “self-supply” and are required to pay to the CRA the GST or HST on the entire fair market value of the home including the land. (You can claim back the GST/HST you paid on construction as input tax credits, if you have kept all your receipts.) There is an exception if you were genuinely building the home for your own residence, and not as a business venture — but you will have to convince the CRA of that. If the CRA comes after you for building or renovating a home, also expect an expensive GST/HST assessment on top of the income tax assessment The combined cost can be devastating.
GST/HST new housing rebates
The GST/HST new housing rebate will refund to you up to $6,300 of the 5% GST on a new home or condo, plus up to $24,000 of the Ontario portion of the HST, if the property is in Ontario.
One of the main conditions for the new housing rebate to be available is that you must buy or build the house for use as your (or a close relative’s) primary place of residence.
If you buy or build a new house in Canada, but your primary place of residence remains outside Canada, then your house in Canada would be a secondary place of residence and would not qualify for the new housing rebate.
Also, if your intention at the outset is to flip the property, you don’t qualify for the rebate, because even if you live in the home, it’s considered part of your inventory, not your “primary place of residence”.
The CRA has been assessing taxpayers to recover the new housing rebate in these situations.
Unreported capital gains
The sale of a property for an amount greater than its cost generally leads to a capital gain. In most cases, capital gains are taxable and must be reported to the CRA. Whether the capital gain is taxable or not can vary, depending on whether the property is a principal residence and where the taxpayer is resident.
If the seller of a property has lived in Canada, and during that period the property was their principal residence, they may avoid having all or part of the tax on the gain on selling the property, due to the principal residence exemption. However, as noted above, if they bought the home with an intention (or even a “secondary intention”) of selling it, the gain is business profit and they cannot claim the principal residence exemption.
A non-resident who invests in real estate in Canada is liable to pay tax on gains that arise from the sale of the property and is generally not eligible for the principal residence exemption.
There are rules related to the disposition or acquisition of certain Canadian property that require non-residents who sell Canadian property to notify the CRA and to pay an amount to cover their estimated Canadian tax liability. This protects the Canadian government’s ability to collect tax that would otherwise be payable upon the sale of a property.
Unreported worldwide income
An individual’s residency status is critical in establishing their Canadian tax liability and the tax treatment of their worldwide income. Residency status should not be confused with citizenship. For example, a citizen of a country other than Canada who has significant residential ties in Canada may be deemed to be a resident of Canada.
Residents of Canada have to report their worldwide income to the CRA, while non-residents only have to report their Canadian-source income, unless a tax treaty provides otherwise. An individual’s residency status is therefore essential in determining what income must be reported.
An individual’s residency status is determined on a case-by-case basis in light of many facts which include:
- residential ties in Canada;
- purpose and duration of visits outside Canada; and
- social and economic ties outside Canada.
Real estate records are often a way for the CRA to start an audit of an individual that expands into looking at the person’s entire lifestyle. If the CRA believes that your lifestyle indicates your income is higher than you have reported, they will assess you for the missing income. Then it’s up to you to provide you didn’t earn that income! (Yes, the onus is on the taxpayer to disprove an income tax assessment.)
CRA audit activity in real estate
For the year April 2015 to March 2016, the CRA completed 1,339 income tax audits and 525 GST/HST audits in real estate. This resulted in assessments of more than $17 million of income tax — with over $9 million in penalties — and $32 million of GST/HST.